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What's in Your Sales Compensation Philosophy?

By: J. Mark Davis, Managing Principal, Valitus Group, Inc.

Beginning a few years ago, there was a lot of discussion around the need for companies to establish a “total rewards philosophy.” Depending on whose definition you subscribe to, the total rewards philosophy helps articulate a company’s point of view on a whole host of “people programs,” including pay, benefits, the work environment, learning and development, etc. In short, it suggests being intentional about the role of the various reward programs in supporting strategic business objectives and defining organizational culture.

Similarly, the sales compensation philosophy seeks to clarify the role and defining parameters of the sales force reward system. For whatever reason, few companies I’ve encountered have bothered to take a stab at articulating their sales comp philosophy. Those that have understand the benefits of establishing some rules of engagement for how a sales compensation plan is designed and administered. Think of it as defining the playing field. The sales compensation philosophy clarifies the boundary markers. It doesn’t call the plays; it simply defines the boundaries within which the play must occur. Within a sound sales comp philosophy exists the flexibility to creatively design sales compensation plans that align with macro business objectives as well as with the nature of the various roles in the organization.

Twenty-Three Key Elements (Give or Take a Few)

There are numerous potential elements that frame a sales compensation philosophy, but not all will be meaningful or relevant to all companies. In other words, there is no finite list of elements that define one. How some of the elements are defined will be universal across the organization, while others may differ relative to a specific business, role, or geography. The following is a laundry list of potential sales comp philosophy elements, many of which reflect issues I've seen companies struggle with on a reactive basis. I've segmented the list on the basis of those pertaining to plan design versus ongoing plan administration. None of these suggest a right or wrong answer - only that they comprise some of the important considerations in helping an organization frame the sales compensation playing field.

Plan Design Elements

• Eligibility - This defines which functions and/or roles are eligible to participate in some form of sales compensation plan; e.g., “Customer-facing roles, including direct sales, indirect channel sales, pre-sales support, post-sale support, and all sales management roles are eligible for sales compensation.”
  
  
• Key business objectives - This should clearly mark the key organizational measures of success that the sales force has a direct role in achieving and that the sales comp plan must align with.



• Performance measures that support those business
  objectives - These are the key performance metrics on which incentive compensation opportunities are paid; they should directly align with the key business objectives. This may result in a pre-approved menu of performance measures from which to choose during the sales comp design process.



• Individual- versus team-based performance measures - Will performance be measured on an individual or team basis? The answer may well differ by role and by performance measure.
  
  
• Cost-of-sales versus cost-of-labor - This speaks to the fundamental approach to setting target pay levels and funding incentive payments. A cost-of-sales approach is an internally-focused perspective that says, “I can afford to pay salespeople $x or x% of net revenue. Therefore, that defines the sales compensation opportunity.” A cost-of-labor approach is externally-focused and says, “We set pay levels and compensation plan parameters relative to prevailing practices in the competitive labor market.” Most organizations operate in some combination of these two perspectives.
  
  
• Definition of the competitive labor market - To the extent you’re not completely in the cost-of-sales camp, in which case the competitive labor market would be meaningless, this simply indicates where you look externally to understand competitive sales compensation practices. Consider the labor markets from which you recruit as well as those to which you lose sales talent.
  
  
• Targeting total compensation levels vis-à-vis the market - Will you be a 50th percentile payer or does your go-to-market and people strategy require that you pay higher (e.g., at the 75th percentile)? The answer may be different when discussing base pay versus target incentive compensation levels.
  
  
• Budgeted funding versus self funding - Will anticipated sales compensation expenditures be budgeted on the basis of some expected distribution of performance or will incentive payments be self-funding; i.e., paying only when sufficient profit or revenue is generated to pay for them?
  
  
• Individual incentive earnings versus company profitability - Similar to the funding mechanism question, should any portion of the sales incentive opportunity be withheld if the company misses its profit target?
  
  
• Fixed/variable pay mix determination - On what basis will the fixed/variable pay mix be determined? If base pay levels are found to be too high relative to the target incentive pay, is the company willing to reduce base pay in order to fund a more meaningful incentive opportunity?
  
  
• Desired dispersion of incentive pay - How much should the top or 90th percentile performer earn as a multiple of the average or target performer? What about the desired dispersion between the top performer and the bottom performer?
  
  
• Commission versus quota-based bonus - Is management comfortable with paying commissions or do they prefer a more managed approach to incentive compensation in the form of a quota-based bonus?
  
  
• Caps - Should the upside incentive compensation opportunity be capped or uncapped? This answer may well differ by role and even by individual incentive plan component (e.g., the monthly commission is uncapped and the quarterly team bonus is capped).
  
  
• Minimum performance thresholds - This speaks to whether you will pay incentives from the first dollar sold versus requiring a minimum level of performance before incentives begin to pay.
  
  
• Formulaic versus discretionary - Should the determination of incentive payouts be formulaic (and, therefore, defensible) or will management discretion be involved in the process?
  
  
• Uniformity of incentive plans across geographic or organizational lines - To what extent should sales incentive plans be uniform across organizational (e.g., division or channel) or geographic (e.g., domestic versus international) lines? Where will localized differences be tolerated or encouraged?
  
  
• Base salary levels - Do individual base salary levels fluctuate within a defined salary structure or are salary levels uniform for all incumbents in a given role?

Plan Administration Elements

• Sales credit timing and practices - When multiple sellers are involved in the sales process will you split credit among the players, totaling no more than 100% of a given sale? Or will you grant a multiple of the value of the sale (e.g., up to 200%) and adjust performance expectations and govern payouts through elevated quotas? Also, at what point is a sale counted for compensation purposes (e.g., at booking, at invoicing, at shipment, at payment)?
  
  
• Quota management practices - Will quotas be altered (up or down) if some external market force changes the selling potential of a given territory? For example, what if the largest single account that comprises half the revenue in a territory goes out of business? What if a new Wal-Mart distribution center opens and doubles a territory’s potential? If you plan to actively manage quota levels, then what’s the process for and who’s involved in arbitrating these changes?
  
  
• Participation in multiple plans - Will sales compensation-eligible roles participate in other non-sales incentive plans? For example, will senior sales managers also participate in the annual management incentive plan or the long-term executive incentive plan? Will sales reps also participate in the annual employee profit sharing plan?
  
  
• The use of supplemental incentive programs - What are the guidelines for using contests, spiffs, or an annual recognition program to supplement (and not conflict with) the core sales compensation plan. This may define such parameters as frequency, form of payment, and measurement focus.
  
  
• Pay and performance communication - How will changes to a sales compensation plan be communicated? Will information on plan details, including base salary structure and the incentive targets for various roles be openly shared across the sales organization? Will individual sales performance results be posted for all to see?
  
  
• Sales compensation plan administration - Who owns the administration of the sales compensation plan (e.g., centrally at corporate versus delegated to the business units)? Similar to the quota management topic, who has authority to make changes to the plan or ongoing administration process?

Moving Right Along

You will likely think of other useful topics that should be (or is already) covered in your organization’s sales compensation philosophy. The point, however, is simply that you should have one to serve as helpful guard rails as you travel the road of managing the sales force. Again, the primary purpose of the sales comp philosophy is to establish the rules of engagement that govern how the sales compensation plan is designed and administered. As the philosophical elements described here suggest, there are a number of issues that will arise sooner or later. My position is this: it’s generally better to have considered your position before the need arises.