How to Develop a Sales Compensation Plan

Developing a Comp Plan

One of the keys to running a successful small business is developing a sales compensation plan — specifically one that’s good and fair. Unfortunately, many businesses don’t know how to develop a sales compensation plan.

In this post, we’ll set out to solve that problem. We’ll also delve into critical sales compensation plan details, such as setting goals, measuring performance, finding a balance between pay and incentives, and updating the plan to align with current market conditions.

I. Good and Fair Compensation Plans

Before developing a sales compensation plan, it’s important to understand the components of an effective compensation plan. Certain elements must be included, and certain misunderstandings must be avoided. In this section, we’ll discuss those topics and more.

Defining a Good Sales Compensation Plan

There are two key requirements of a good sales compensation plan: it must motivate salespeople to excel and achieve agreed-upon revenue goals, and it should serve both your sales reps and your company well because each side rises and falls together. Sales reps work to meet specific goals that benefit themselves, but they also help your company grow in the desired manner.

Whatever payment structure you choose, your compensation plan should motivate your sales reps to make the most money they can (for themselves and for your company). To ensure that remains the main objective, keep it clear, direct, and accessible so your teams can easily understand the goal and never stop working toward it.

Misunderstandings About Sales Compensation Plans

One of the biggest misconceptions business owners have about sales compensation plans is that they’re designed to incentivize results rather than behavior. Ultimately, you should want your sales reps to exploit the compensation plan you have in place — yes, really. If their goal is to make as much money as possible, that “exploitation” benefits both them and your organization.

Further, it isn’t just an overall goal that you want to drive your sales team toward. Proper compensation planning needs to incent more heavily where you want that revenue to originate — consider the most profitable products, the most desired industry verticals, and new companies with whom you don’t currently do business.

The misconceptions and misunderstandings don’t stop there, though. Businesses too often think of their sales reps’ compensation as just a paycheck. Sure, employees value pay, but they also respond to variable benefits like retirement, healthcare plans, and bonuses. These compensation options don’t just attract talent — they help companies retain talent.

A clear understanding of these misconceptions is important because letting them linger can lead to mistakes in the way businesses develop or use their compensation plans. Without the right knowledge, you can build a compensation plan that doesn’t encourage the exact behavior you desire, that cannot be fully understood by your sales team, or that won’t attract the sales talent your organization so badly needs.

When businesses don’t understand how to structure a sales compensation plan, they might not find the right balance between base and variable pay. Most companies offer a balanced compensation mix that includes both salary and variable pay, but their compensation plans and overall business will suffer without knowledge of how to do that.

Finally, you risk not making it clear how your sales compensation plans and goals directly connect to and impact your employees. Every sales rep should easily be able to see how their effort helps shape individual and overall company success.

Small Business vs. Big Business Compensation Plans

Companies structure sales compensation plans in different ways depending on their organizational goals, resources, size, and team needs. Some might offer a more substantial salary, while another might make commission the biggest earning opportunity.

Before designing a plan that best fits your company, you should think through a few things. Start by determining your compensation budget, the expectations of your sales team, and what results you seek. While you can look into how others in the industry structure their compensation plans, you shouldn’t just mirror those plans. Just as no two people are exactly alike, no two businesses are either. Effectively designing a compensation plan involves a certain amount of tailoring and personalization to achieve your unique goals.

If you do evaluate other companies’ compensation plans, be mindful of the size of the operation in relation to yours. Large companies are more able to absorb the impact of a plan that doesn’t pan out, but small businesses don’t have the cash flow or margin to make the same mistake. You can get ideas by examining what other big businesses are doing, but compensation plans will never be effective if they’re treated as one-size-fits-all solutions.

Sales Compensation Plans and Success

Small businesses don’t have a lot of room for error, which means it’s vital for them to attract high-performing talent. One way to do that? Build a compensation method with strategic planning at its core.

It’s key for small businesses to keep their compensation structures current and competitive in a changing market. Compensation plans need to change each year. Why? Because your needs and goals change each year. Determine the overall revenue you desire, and decide how much of each product, vertical, or revenue type (new or existing customers) you desire to hit — not only your overall goal but also the mix you prefer. Then, build a compensation plan that encourages your sales team to sell exactly what your company wants.

When recruiting the top sales talent, small businesses benefit from keeping everyone on the same page regarding how compensation will be structured and measured. And when everyone is on the same page, there’s a significantly better chance that business will thrive while employees will stay and grow with the company.

II. Base and Variable Pay

Part of developing a good compensation plan is establishing the right balance of base and variable pay for sales teams. What are the ins and outs of that process? What variables factor into the decision? Where can small businesses go wrong, and how should they determine their ideal mix? The following section will answer these questions and more.

What to Know Before Setting Base Pay

Before taking any action, you should first learn how to set the base pay for your sales reps. It’s key to offer pay that is competitive in the industry and to consider that base salary in relation to total possible earnings. 

If base pay, for instance, is more than half the total expected compensation, your team might not feel as motivated because they will be making the bulk of their money without expending any effort. If it’s well below half, though, you might struggle to attract top-flight talent because they’ll go somewhere they feel offers a more secure pay structure.

Regardless of the specifics of your compensation plan, it needs to drive your sales team forward. Having a strong base pay plan that still properly motivates your team members will allow you to recruit and retain the best talent, and it will also help you identify which salespeople are thriving and which ones have room for improvement.

Variable Pay Options

If you’re working to determine how to incentivize your sales team, there are many forms of variable pay that small businesses can offer to employees. Whether your main offers beyond base pay are commissions, bonuses, SPIFFs, or draws, each comes with its own advantages.

Commissions, for example, give you flexibility because they can either be a flat percentage or gradually increase based on performance. Often, you can pay commissions before sales teams earn them, especially if the employees are getting established; in this case, the commission would take the form of a recoverable draw. Bonuses offer a great way to pay based solely on achievement, which creates relatively little risk for employers. 

SPIFFs can offer a certain amount of money for selling a newly launched product and motivate sales employees to perform well in the short term. Meanwhile, draws let you pay some in advance and tend to be a good fit for businesses with longer sales cycles, seasonable businesses, or those that are just getting started because it evens out future compensation and leaves them with something in the interim.

Striking a Balance Between Base and Variable Pay

As we mentioned in the first section on base and variable pay, one of the biggest mistakes you can make as a small business owner developing a compensation structure is not keeping your base pay close to 50% of expected compensation.

Sales representatives need a base salary that is high enough to meet their basic financial needs but not so high that it keeps them from working toward incentive pay. This means, ideally, base pay should fall between 40% and 60%.

Your sales team might be highly motivated to sell if you offer only a commission, but they will actively look for other roles that provide them with a more secure base salary. If you do make commission your sole variable pay offering, base it on sales or profit but avoid basing it on sales over which reps control the pricing. When offering bonuses or other incentives, you encourage reps to push themselves because their effort leads to rewards.

Determining Base and Variable Pay Policies

There is an old adage about base pay percentage: “I want my reps to eat hamburger, not steak.” This might sound harsh at first, but it ultimately means that you don’t want your reps to “eat steak” just with their base salaries. The steak reward comes when they earn it through variable pay.

Striking a balance between offering too low of a base and too high of a base is tricky. If it’s too low, talent won’t join your team. If it’s too high, your sales reps won’t be pushed to exceed expectations.

Salespeople are wired to succeed by exceeding. They set goals and work to meet and surpass them to improve performance consistently. That said, the most important part of setting target compensation and benefits is finding the balance between base pay and incentives.

III. Setting Compensation Targets

In this section, we’ll dive into setting compensation targets. You need to know what a poorly structured compensation target looks like, how badly structured targets lead to burnout, and how to set the best, most reasonable targets for your own employees.

Off-the-Mark Targets and Their Consequences

When sales compensation targets aren’t structured well, it hurts you and your employees. If you set them too high, they don’t motivate your reps to work harder. If they’re too low, you end up paying too much money for modest sales achievements — and as a small business, you can’t afford to do that.

In the end, the reason you develop and implement a sales compensation plan at all is to incentivize your sales staff to achieve more. Because of that, the targets you set should be attainable and realistic. If they’re not, your team won’t work hard to meet them because they’ll feel like they can’t achieve them.

Aiming too high and expecting too much aren’t the only hallmarks of poorly structured compensation targets, though. Small businesses that aim for the same targets every year without updating them are also taking the wrong approach. Because there are always changing market conditions, goals, and needs, it’s key to evaluate your targets annually to determine whether they’re working well or need improvement.

If targets are too high or aggressive, they’ll cause even the best and toughest salespeople to feel burned out. It’s normal for employees to experience some workplace anxiety, but feeling it for a prolonged period of time over something they can’t control is not healthy for them or your business. Be mindful of the consequences that come with setting unrealistic compensation targets.

How to Set Reasonable Targets

How do you set reasonable targets? What guidelines do you follow? Start by setting a “stretch goal” — an achievable sales goal based on slight stretch and progression. You can base these goals on either individual sales reps or territories, keeping in mind that it’s harder to sell in certain geographic areas or with some clients.

However, the best practice is to assign a customized goal to everyone rather than a catchall target for the team. A multitude of things can impact performance, including seniority, experience, and the size of a rep’s pipeline.

Think of it this way: If a rep has $3 million of expected revenue in her pipeline for the next year, her goal shouldn’t be the same as a rep whose pipeline has $1 million of expected revenue. The playing field wouldn’t be level. By tailoring the goals to the rep, you’ll see far more success.

IV. Updating Compensation Plans

Now that we’ve discussed the requirements of a good sales compensation plan, determining base and variable pay, and setting compensation targets, we’ll discuss the importance of keeping compensation plans current.

Changing Conditions and Sales Compensation Plans

Changing market conditions can upend your sales compensation plan if you aren’t vigilant and proactive. Too many small businesses develop a sales plan that works and then use it for years to come without updates to meet the needs of an evolving talent pool and economy.

Adjustments to compensation plans don’t always need to be major. Sometimes, changes will be small, and work can continue as normal. But businesses that don’t take the time to revise their plans each year put themselves at a serious competitive disadvantage. This is significant, considering one of our recent surveys showed that only 30% of companies make annual compensation plan updates.

Your sales compensation plan needs to stay current to not only match market conditions but also to help you attract top talent. Having great salespeople to drive growth is crucial for small businesses, so it’s necessary to offer compensation that aligns with the talent market.

Mistakes When Updating Compensation Plans

When updating your sales compensation plans, be mindful to make changes based on how easy or difficult it is for your sales reps to achieve their goals. Changing market conditions aren’t the only reason to stay current.

If you find that some sales reps can’t achieve original quotas — or that they easily surpass them — it’s important to be ready to adjust. Your sales compensation plan is meant to serve as a reward system for employees rather than a punishment for falling short.

When you consider just how many factors — economic, personal, financial, and more — can impact sales, you see just how necessary it is to adapt and evolve as needed.

How to Update When Market Conditions Demand It

If you don’t change your plan to reflect market conditions and the new goals you desire, you can make it too easy or too difficult for sales reps to achieve their goals — while the organization hasn’t satisfied theirs.

If there is too much of a chance (or not enough) that your reps will hit their goals, there isn’t much incentive to try. The problem doesn’t stop there. Turnover increases when salespeople aren’t being challenged or are being challenged too much; they want to work for an organization that takes care of them. Be creative to ensure you’re working toward this win-win conclusion.

Compensation plans should be dynamic. To align with your revenue goals, build a plan that moves sales reps to action and motivates them to succeed. How can you do this? Start by looking at salary surveys that examine sales employees’ base and variable pay as well as the total target compensation versus actual compensation — both metrics that measure sales performance.

Beyond this, look at occupational and salary data from the Bureau of Labor Statistics or from Glassdoor or Payscale for base pay and variable ratios. Market data allows you to strategically establish targeted sales compensation plans for every role.

In the end, learning how to develop a sales compensation plan requires you to also learn the requirements of a good compensation plan, the compensation budgeting process, how to incentivize your sales team, and the importance of keeping your plan updated.

It’s clear that having a strong sales compensation plan is one of the primary keys to running a successful small business. We created a sales compensation checklist to help you do exactly that: Download it here to start developing your compensation plan and watch how it strengthens your business.