How to Develop an Effective Sales Compensation Plan

How to Develop an Effective Sales Compensation Plan

Deciding on the right plan to compensate your sales team is both critical to your business and one of the biggest challenges you’ll face.

Striking a balance between realism, ambition, motivation and setting achievable targets that are also enough of a stretch to increase revenue is a bit like juggling chainsaws with greasy hands - very tricky and loaded with the potential to go incredibly wrong.

There’s no ready-made solution. Each industry and individual business will have its own needs and objectives. Some choose to pay purely commission, others opt for a revenue share model. Some set individual compensation plans while other find it more effective to reward team performance.

Understanding your own business’ needs and objectives as well as the behaviors you want to encourage in your sales staff is the best way to lay the foundations for success.

Clearly define your business objectives

A mature business selling multiple products or complex services will have very different objectives from a lean startup focused on doing one thing very well.

  • Are you in a client acquisition phase?
  • Are you established with a solid client base and simply looking to drive more revenue by effective upselling?
  • How long is your sales cycle?
  • Do you have any major product or feature launches planned?

Deciding and agreeing on these parameters is a task for your senior management team. Answers to these strategic questions will inform everything else you do.

Also consider the human element.

Are you looking to attract new talent or simply retain your best people?

Are you OK with regular staff churn?

Or are you planning to invest in your employees for a longer period?

Understand which system works best for you

There are many ways to structure the monetary side of your compensation plan, but almost all of them are a blend or variety of the following four options:

  • Profit-Based: Sales commission rates in this system will generally change as margin levels increase so your sales team will, in theory, be working towards organizational rather than individual success. The more the company makes, the more the salespeople make.
  • Revenue/Quota: Probably the most famous and traditional way to compensate sales teams - this system is based on sheer volume achieved over the previous sales period or on a percentage of a quota achievement by the individual or team.
  • Balanced: As the name suggests, this is a blend of the two options above. Compensation is based on margin, revenue and possibly a third component, such as quota attainment or completed sales activities.
  • Team or individual: In a team structure, bonuses go to all team members if sales goals are achieved rather than each salesperson being rewarded only on their own achievement. Your decision here will depend very much on your company culture, the reliability and predictability of forecast sales, and the skills of individual team members.

Make sure you understand the true cost of sales

Calculating the cost of sales is a vital part of planning any compensation package.

If you end up paying out more in bonuses than you’re marking as profits - your business will be in trouble very quickly.

At its most basic, you simply look at your team member’s salary, plus the commissions they stand to earn if they meet their targets completely, then add any potential bonus opportunities. Now divide this number by the total revenues that person brings to the company to obtain the percentage.

Your Simple True Cost of Sales Formula




Of course, it helps to factor in marketing costs, equipment, office space, utility bills, travel expenses and even the cost of beverages and snacks in the office. So many unsuspecting sales managers have had their profit forecasts cruelly slashed by hidden costs.

You’ll need to do some serious legwork here, modelling out as many potential scenarios as possible.

What if someone significantly overshoots their target or doesn’t come anywhere near it?

Find the perfect meeting point of cost and revenue for your company.

Don’t overlook the human element

There is no quicker way to destroy a sales team’s motivation than setting unachievable targets.

You’ll leave them underpaid, overworked and stressed out.

You need to keep people motivated to want to sell every day and give them the opportunity for some real rewards if they do over-perform. On the flip-side, overly generous sales compensation plans with easy to achieve targets can easily see your revenue stagnate or the cost of sales shoot up and start biting into your profit margin.

There’s a famous saying coined by a company not far from here that goes: In sales you can’t control results, only your own actions.

An activity-based sales model that ties sales compensation to the amount of activities completed rather than the number of sales made can have surprisingly good results.

Make sure the salesperson’s role is clearly defined

Paying your sales team on a commission basis only and then expecting them to manage client relationships, contract fulfillment and invoicing may work if the commission structure is truly generous, but it is more likely that they’ll end up doing all the extras poorly or in a rush as they try and get back to selling.

If you expect them to do other tasks it is generally better to pay them a set base salary as well and make it very clear that this is tied to their non-sales activities.

Give serious consideration to which behaviors you want to drive.

If you’re looking to set up long term relationships with clients and garner return business, your sales team will need enough time to nurture these relationships without feeling desperate to move on to the next sale so that they can boost their commission.

Finalizing a winning sales compensation plan

Here are a few final things to consider when structuring your compensation plan.

Your company’s size, reputation and perceived security matters.

If you’re an established, dominant player in the market with a loyal customer base and a steady revenue stream you can usually afford to pay lower commission fees and larger amounts as base pay.

As a start-up or new business you’ll need to really incentivize growth and make your package attractive enough to lure top talent. Oddly enough this may lead to a situation where the cost of sales is higher for companies making less money.

If you’re a new player in the market or you have a product or business that is perceived as risky, you may also need to offer a larger base pay package to attract good salespeople. You can always structure this to evolve over time, where base pay reduces over say a six month period to reward and drive successful selling.

If you’re looking for rapid growth you will need to develop a plan that rewards salespeople at shorter intervals. Established companies have the level of trust and reliability that makes an annual sales bonus viable. If your staff have doubts whether your company will even exist in a year’s time, quarterly bonuses will make a lot more sense.

Lastly, it really pays to make the compensation plan fun or to add a an element of gamification to your sales teams targets. A happy sales team is (usually) a successful sales team.

Here are some resources to help you get going:

Developing your plan will take hard work, careful planning and constant monitoring and tweaking. But once you hit that sweet spot where salespeople feel challenged, motivated and rewarded all at once, and you’ll be set to reap the rewards.

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