Compensation Plans

Compensation Plans

In the past, I would survey my peers and recruiters to determine salary rates for compensation plans. With today’s Internet, there are locations that list industry salary ranges–one of the easiest methods is still to check the job boards and see what companies are willing to pay. Salary.com is the most popular.  Glassdoor.com is another great source for compensation plans salaries (with feedback directly from those within the company).

Employment Contracts

Disclaimer: This is not legal advice, but practical advice (my opinion) to help achieve financial and security objectives. Please consult an attorney to discuss the legal implications.

Most companies prefer to maintain the “at-will” relationship which allows companies to hire and fire at will–it also allows an employee to “walk at will” (although there may be some stiff handcuffs). However, in the at-will relationship, companies often run lopsided agreements and attempt to tie up employees with “golden” handcuffs that are not so “golden.” For example, they retain their “at-will” status, but then seek to enforce a non-compete clause, a nondisclosure clause (including not discussing that you even had a clause), repayment of relocation clause (sometimes even if fired), plus clauses that prohibit stock vesting if released even a day before the prescribed time. In return, they offer you employment.

In the past, employment was a two-way commitment. However, in today’s economy, corporations (which can be referred to as “cold steel buildings” – not flesh and blood) are forced to set aside loyalty to employees for stockholder profitability. As a result, corporations are not able to look after their employees and employees must ensure their own security. One way to do this is to ensure the compensation plans include an employment agreement.

The most important compensation plans agreement that employers want is a time and confidentiality commitment. The most important agreement that most employees want is job security, or better yet, financial security–even if they leave or are let go.

The Offer Letter – Compensation Plans

The first agreement most employees face when reviewing compensations plans is the offer letter (which states the benefits and stipulations of employment). According to John Lucht, in his book, Rites of Passage at $100,000+, says, “… every time you start a new job, you can have an employment contract…even if you don’t receive a paper with the term “contract” on it.”

The offer letter can be the most valuable contract you obtain. I recommend that you never accept a position without having the company (small or large) put your offer in writing. Companies will seldom commit to a 3-5 year contract, but they will often enable a 6 to 12-month severance, or a “12-month advance notice.” In addition, the offer letter can stipulate reporting structure, that there will be no relocation, guaranteed salary, and title, cliff vesting upon a change of control of the company (or reporting structure), etc.  I highly recommend John Lucht’s book! (it contains samples that you can model)

Personally, I prefer a well written “counter” offer with termination agreements rather than a contract–I usually get more benefits out of it (since I can bypass the attorneys), and the terms can last longer (ten years down the road–since your severance is based on the salary at that time, not when you started).

Formal Contract – within the Compensation Plans

Formal contracts typically spell out every stipulation and should always be reviewed by a seasoned, practicing employment attorney. These formal agreements with compensation plans are rare unless you are the CEO or an officer of a company that was acquired. A good attorney can provide advice such as the following (shows some fixes that were made by an attorney during one of my contracts):

• The “company” has been defined as the company, its subsidiaries (including partially owned), and its alliances. This would make it impossible to compete afterward with half the industry which is certainly not the intent, but the “too broad” definition can be constraining later.
• You can limit the non-compete to the specific product line at that time–eliminating a clause that prevents competing with everything a company is involved in (i.e., a generic non-compete with IBM could exclude you from half the high-tech industry, versus a non-compete with just the product line (pc laptops) that you will influence).
• Removing clauses that are vague, such as “for cause.” This should be spelled out and agreed to.
• Bonuses should be tied to specific deliverables that must be decided and signed within 4 weeks of employment or the bonus is granted by default.

These are some of the helpful tidbits within the compensation plans that a good attorney will help you resolve and negotiate.

The main point is to ensure that you are properly protected and have some form of security as part of your employment–if you are a “good” marketing person, you will often have to buck the “engineering” or “accounting” driven trends to do what is right for the company–in spite of itself (and you need protection to ensure that you don’t wimp out and back down, afraid for your job, when you should be in the battle to do what is right).

Registered users now have access to a very comprehensive sales compensation plans (contains samples, policies, concepts, plus a sales tracking spreadsheet to optimize the activity and skills of your sales team.  Following is just part of the sales comp plan (the Guidelines):

Chanimal Sales Comp Plan Guidelines

Note: This document should accompany the Chanimal Sales Compensation Plans template.

Objectives

There are two objectives and two perspectives that must be taken into account with effective sales compensation plans—the company’s need to meet consistent revenue expectations in the short and the long term, and the sales reps need to be compensated competitively for the associated effort and risk.

If a company does not meet the revenue objective, the company may have layoffs, cut expenses and will not achieve desired growth. If the sales rep is not compensation competitively, they leave and the company loses interim revenue (which includes weeks of lost revenue and ramp-up time to re-build the sales pipeline), and may not be able to find an equivalent sales replacement (not as skilled or motivated).

As such, it is critical that the company and salesperson strike a win/win agreement.

Variable and Fixed Compensation Plans Mix

A salesperson typically has fixed and variable compensation. Some sales positions are 100% pure commission. This is fine for companies the invest in sales training, have products that have a short sales cycle, sell well, and have a track record of providing consistent revenue for consistent effort.

However, pure or high commission is not good for sales that have a long or unknown sales cycle. In these cases, the salesperson has to essentially cash flow the company and assume most of the risk. A salesperson doesn’t have VC funding or major ownership in the company, so it is not a win/win scenario for them to assume most of the risk in the hopes that they will get paid quick enough to pay their bills.

In addition, the salesperson has to assume the risk that the product meets the market needs and that it will ship on-time. If the product ships late, their commission is late and they may run out of cash before they receive sufficient commission to survive.

Following is a Sales Cycle grid that shows possible ratios of variable versus fixed income according to the type, price and sales cycle of various products:

Other factors to take into account when deciding the compensation plans mix is the experience of the sales rep. If a rep has a consistent track record and is highly skilled, then they are a proven commodity. As such, the risk to the company is low. In some cases, the salesperson may have faith that they can close, so they are interested in working a higher percentage on commission, but only for medium to short-term sales cycles.

For longer sales cycles, the salesperson may need a higher base to maintain a similar cash flow as their previous position, while they build their pipeline. In addition, the company with a short or long sales cycle does not have as great a risk by paying a higher percentage base to a “proven commodity.”

Sales to Commission Ratios

The industry benchmark for a profitable software company ranges from $100 – $125k of revenue per employee (assuming a US-based workforce). Some company ranges are much higher, while some can still be profitable with lower ranges, but these typical employee international development teams (10 to 1 cost reduction in India, Philippines, 7 to 1 in China, etc.).

The high-tech industry benchmark ratio of direct sales to commission is 10 to 1 (10% of the sale should be used to compensate direct sales compensation (total comp includes commission, salary, and bonuses (indirect comp (health and life insurance, company car, expense account, 401k matching, etc) are too varied from company to company and are not taken into consideration within this model).  In some software companies, this ratio is 7 to 1 (and even lower while developing a market), while other companies with large enterprise sales, like Oracle, might have a 15 to 1 ratio.

All of these ratios only apply to products sold direct. If a product is sold through the channel, we must expect a percentage of the SRP to go to distribution (if using a two-tier model), a percentage to go to the reseller and a percentage commission or bonus to go to the internal or field channel sales rep. Of course, an indirect sales force works 100% commission, is responsible for all their own expenses, often provide first-line support, etc., so they need a higher percentage to cover this expense.

Indirect compensation plans are not addressed within this document. Register to get free access to this comp plan or visit the Chanimal Store.

How Much to Pay – Setting up the Schedule

Using industry ratios for healthy companies, we know we can allocate 10% of revenues for direct sales cash compensation. We also know that the ratio of base to commission varies by the experience of the rep, by the difficulty of selling our product, and the sales cycle.

If we have a seasoned sales rep (a Sr Account Rep) in technology sales and a medium sales cycle, we would typically pay 50% of the “total comp” plan as a base and 50% commission. Of course, these ratios can change according to the factors reviewed previously.

We determine the total compensation for a salesperson based on their prior total base, commission, bonuses, and benefits (which often tell us if this is a “highly effective” or “average” salesperson) and by the current market rate—using regional and national (if they had to re-locate) averages. One place to find these averages is Salary.com.

Salary.com lists a range and a median for total compensation.  For example, if we are trying to hire a Sr. Account Rep in Kansas City, KS, the lower range is $47,461 and the higher range is $86,093, with a median value of $76,650.  We obviously don’t want to hire the lower performers, so we have to assume we will need to pay between $76k to $90k to get better salespeople.  These amounts from Salary.com calculate the total direct cash compensation–they do not take into account additional indirect benefits that may or may not exists (health and life insurance, company car, expense account, 401k matching, etc.).

Using this example, if our total cash comp target is $90k, then this person should pull in $900k in sales (the revenue amount may scale up or down depending on the sales cycle and the normal ramp-up period for a new salesperson).  We would pay a base salary of $45k, with commissions, bonuses, and awards making up the remaining $45,000.

We then have to decide how to divide up the $45k. The percentage of sales in this example is 5%. However, we may wish to pay a percentage (say 4% ($36k)) for commission and reserve another percentage (1% ($9k)) for weekly and/or monthly incentives. The degree that we divide the mix up is dependant on the bandwidth of our sales management and how well we can pre-define, and manage the process.

How to Pay

Short and long-term rewards map to the company’s need for short (cash flow) and long-term sales (growth). Following is how each component of a sales comp should be paid to meet these objectives:

Base Pay

The base salary is usually paid every two weeks. Nothing unusual here. The base salary meets the day-to-day needs of the salesperson. However, we work for want we need, but we work harder for what we want. Commissions and incentives fulfill wants and help motivate sales to work harder.

Commission

The commission should be paid as close to the sale as possible—period. Sales should also be paid on the PO (when the deal was actually closed and the order was received)—not paid when shipping gets around to sending product, or be at the mercy of accounts receivable gets around to collecting (sales did their job and should not be at the mercy of an accounting department that does not have the same motivations (they get most of their total pay regardless).  Bonus accounts receivable if you want faster collections.  However, if there is a cash flow issue, then the commission should be paid when the check hits the bank.

Typical scenarios include:

• Pay commission ASAP after the purchase order—usually by the next paycheck. This is the best scenario.
• Pay monthly. The commission should only be paid this late if you don’t have the system in place to automatically account for commissions, or payroll can’t handle the workload.
• Pay quarterly.  You better be public and trying to meet quarterly numbers or your sales team ratio should be 70% base to commission or higher–or this makes no sense from a motivation and reward standpoint (which is a major component of a good sales person’s mentality).  One company I assisted liked to pay quarterly, just so his salespeople would be forced to stick around to get their commissions (or they would lose their commission)—this is unethical…sales already earned their commission and it isn’t our money to play with as extortion to keep people from quitting (this company had several problems).
• Pay annually. Are these sales or some other department? This is usually a bonus program, not commission. I can’t think of an example when this is motivational and would increase sales.

Multipliers

In order to reward a salesperson to hit quota early (quarterly and annual), we set up multipliers. These multipliers increase the commission amount and kick in when the quarter and/or annual quota is obtained. These range from 1.5 to 3 times the commission percentage within the industry (some are much higher if a salesperson exceeds the quota).

For example, if a person makes a 2% commission and hits 100% of quota, then their commission is multiplied by 1.5% (so they received 2% x 1.5 or  3% on everything closed (when a qualified PO is received) from that point on until the end of the quarter, or year (if they achieved the annual quota). These multipliers can be set at various percentages of quota to encourage desired sales behavior.

At some companies like Autodesk, there are salespeople that blow past their annual quota halfway through the year. They get paid immediately after hitting quota and it then goes up to the subsequent level until the end of the year. These salespeople get rich, but then so does the company with these “super” sales performers. Autodesk further encourages hitting the entire year’s numbers within the first six months by awarding $50,000 cash, but with a caveat—it must be used to purchase a “want,” not a need. The users must actually prove that they purchased a car, a boat, a pool, etc.

Following is the commission multiplier at the associated quota (this applies to the quarterly and annual quota)—everything sold after hitting the quota gets paid the regular commission times the multiple:

 Percentage of Quota             Multiplier

• 100%                                       1.5
• 125%                                       1.75
• 150%                                       2
• 200% and above                     3

*These numbers are random. We should calculate the average and highest percentage past quota that we expect the salespeople to make, along with calculating the highest multiplier breakpoints to determine the correct percentage and multiplier to ensure we create the motivation we desire.

Sales Incentives Bonuses

 In addition to sales commissions and multipliers, some companies use sales incentive bonuses. One company pays a flat $5k bonus when their salespeople hit quota.  Others try to manage the behavior of their sales team with bonuses for achieving KSO (Key Sales Objectives). For example, a company may provide bonuses if a salesperson increases the # of new customers, gets trained, increases sales ratios, etc.

Contest Awards

Contests are great motivators to reward salespeople for short and long term behavior. These can be quota-based (everyone who hits a specific sales number gets to go to Hawaii), or competitive (the top salesperson for the month/quarter/year goes to Europe to watch the Tour De France).

Having been to Hawaii five times, Mazatlan Mexico once and on the company Houseboat trip to Lake Powell three times, plus having attended the exclusive President’s Club Award dinner (which took 4 hours at the most exclusive five-star restaurant), I can testify of the value of these types of incentives. Plus, these kinds of contests help to break the monotony of sale prospecting by providing another reason to work exceptionally hard, aside from just needs.

What to Comp On

We want our compensation to reflect on our objectives. If we want our sales team to call on existing accounts, we comp them on existing accounts. If we want them to behave identical to inbound and outbound calls, we comp them identically (or they will shun the customer that pays the least commission). If we want them to push a specific product, we comp them on that specific product and assign a line item quota to their overall quota.

I helped found the world’s largest high-tech rep firm (with thousands of field reps) that catered to large companies with a shared sales force that did not have product line item quotas. A $200 million division of Microsoft could not get their own sales force to push their product. The division GM still had a sales quota to meet, so they had to hire our company to get effective representation.

Pay on profitability or revenue.

When we pay direct salespeople, the commission is typically based on revenue, and this is usually exactly how we want to pay.  However, there are times when we should base commission on profit margin. One case is when we are selling other peoples’ products (as a reseller, a publisher, or as part of an OEM deal). The reason is because our margin may be very different for different products, which is not reflected by the revenue.

Another reason that might justify paying on profit margin is when sales are continually discounting and the sales manager either doesn’t know how to stop it or is part of the gang (and has enough clout to keep it going). Discounting is an indication that sales do not know how to “sell” the product and it’s value—since they have to keep devaluing it with discounts.  Rather than learning how to position and sell the benefits, and incorrectly devised sales compensation may make it painless for them (but not the company) to “buy” their way in with discounts.

If we don’t have direct control of sales, but we can influence the comp plan, then we may wish to change the commission to pay on margin. When it is suddenly their own money they are giving away, instead of the companies, Sales suddenly figures out how to start selling the product without discounting.

Simplicity

Our comp program must be clear and easy to understand. At one company I worked with, the sales team did not appear to be motivated by their comp plan. During the sales interview analysis, it was evident that sales didn’t understand their comp plan. It took over 1 ½ hour to compile and model all of the information within a spreadsheet before I understood how their comp plan was structured (breakpoints, commission percentage, payout times, etc.)—it was obviously written by an engineer. This comp plan was ineffective and had to be revised and simplified.

Even though a comp plan must be easy to understand, it does not have to be simplistic (straight 10%, “now go to work”). If the plan is profitable to the company, and it is understood well enough that it motivates and avoids conflict and confusion, then it is working.

When to Pay

If we want to encourage sales to sell more, we pay the commission as close as possible to the time of the sale. i.e., “Doggie does trick, doggie gets bone.” Result: “Doggie wants to do more tricks.” We’re not calling sales dogs (or I would be barking with the rest of them) but the behavior does.

If we could, we would pay commission immediately upon the close of the sale. However, this is not always possible since payroll seldom has the bandwidth to process commissions daily. We also may not have the cash flow to pay upon the close of the deal (the PO in hand) but must wait until the check is collected, and sometimes we must wait until the check clears the bank. In many companies, the salespeople are at the mercy of accounts receivable before their commission is paid, or more expensive yet–they are accounts receivable and have to handle collections themselves (which takes them away from making more sales).

In most circumstances, we want to pay one pay cycle (usually two weeks) after the sale is made. In addition, whenever possible, we want to pay on the PO, not when the payment is received or when it clears the bank.  Only if we have a high-base pay, and if we are a public company that lives and dies by the quarter, would we elect to pay quarterly?

One company I assisted paid commissions once a quarter, only for accounts that had paid within that period, required the salespeople to collect the checks, and then paid their salespeople late—as much as six weeks after the end of the quarter. The company also quibbled over whether a sale took a short or long time (and wanted to pay less if it closed quickly). The average sale cycle for this company was 4-6 months so it could take half a year to close a deal and secure the PO and check, another quarter to get paid if the sale occurred early in the quarter, and then another six weeks before the company got around to paying them—as though it was burden paying the team that kept the lights on. This meant it could take a total of 10 ½ months from the first call before there was any commission (and over 4 ½ months of this delay was based on company “policy”). The company wondered why their salespeople were not motivated by cash.

Setting the Quota

We can set quota based on past sales for the product, the territory, the salesperson, etc. In these cases, we review historical data, determine what the person and product can sell, or the revenue we need from this salesperson and set a number.

We can also set quota based on achieving the industry ratio of 10% of sales. For example, if a salesperson wants to make $100k, then he needs to deliver at least $1 million in sales for the company to be in the profitability range for a software company. It’s that simple.

One of the worst things we can do is set the quota so high that it is not achievable—regardless of the activity level or skill of the salesperson.  The best salespeople are pure capitalists. If they know they can’t meet the quota, they go elsewhere.

For example, at one of the divisions of Symantec a new sales director came in and raised the quota for an eastern region from $2 million to $7 million—without doing the appropriate homework. The regional manager was one of the top salespeople in the company, rose to the challenge but could still only achieve 5.3 million. He achieved record sales but missed quota for the first time ever. It cost that regional manager over $200k in commissions that he ordinarily achieved. As a result, he didn’t quit, but he quickly transferred into another division forcing the sales director to scrabble to fill the position with a person who never came close the to previous manager’s sales.

As a rule of thumb, we should expect 2/3rds of our salespeople to hit quota, and 1/3^rd to miss it—typical of a normal bell curve among our sales team. We should also expect some to blow past the quota which helps compensate for the bottom third and ensures the entire company meets its overall financial objectives (these salespeople are saviors and should be rewarded handsomely).

It is also important to understand the cause of not hitting quota. If a highly motivated, well seasoned, exceptionally skilled salesperson cannot meet and exceed quota (at times outselling everyone else)—then we screwed up and are at risk of losing a top performer, all of the associated revenue, and the potential lost sales while trying to find a replacement.

Adjustments

We should not hesitate to modify our compensation plans if they don’t get the desired results. However, there should always be a fair transition period so nobody gets the rug pulled out from them in the middle of a potentially large sale.

Additional Resources

• Registered users now have access to very comprehensive sales compensation plans (contains samples, policies, sample offer letter, concepts, plus a sales tracking spreadsheet to optimize the activity and skills of your sales team.  Above is just part of the sales comp plan (the guidelines).  You can also purchase the comp plan within the Chanimal Store.