How to Build a Sales Compensation Plan (4 Things You Need to Know)
When you start a company, your sales compensation plan isn’t that big of a focus, because well… you have no sales.
That doesn’t mean it’s not a big deal.
When you get up to 200, 300, 500 team members, your sales comp plan is going to play a larger role, so it’s important to have it nailed down early.
We recently interviewed Raphael Parker, VP of Business at Segment, about building sales compensation plans. Raphael joined Segment back when the company consisted of four people. Now they’re close to 100, so he’s personally dealt with the transitions of growing a sales team.
Through his experience, Raphael has incredible clarity on the right types of comp levels, those that can take you through the next several stages of growth and beyond.
He says there are four things to keep in mind when setting a sales comp plan. We’re going to go in depth about each of them here.
1) Overall Structure
The way that sales reps are typically compensated is with a base pay (salary) and avariable pay (commissions). Base plus variable is typically referred to as OTE forOn Target Earnings. So when you sit down with your prospective reps, they’re probably going to ask to know their OTE.
The important thing to keep in mind is that the OTE is aspirational, notexpectational. It’s not a guaranteed number, but it should be something they can reasonably achieve.
The idea is, if a sales rep comes in and does good work, given the situation of your business, the OTE is the total amount of money the sales rep can expect to make. The actual amount you pay depends on many variables: What city are you in? What are expected OTEs for reps? How much experience do you require reps to have? What percentile level are you trying to hire at?
However, one thing everybody has to deal with is determining the typical split in OTE between base and variable. The classic formulation is an even split: 50–50.
For younger companies, you may want more leverage in the variable. Reps can make a bunch of money by surpassing their quotas and through variable pay, but you’re just not guaranteeing much of that through the base. You’re fine with them making money, it’s just going to have to come from them bringing in business.
As an aside, throughout the organization you have different leverage points for different roles. So roles such as sales engineers or account managers will typically have less leverage.
Let’s say you have a sales engineer whose job is to work with four account managers and answer technical questions about your product. They could be awesome at their jobs, but driving the deal to close is ultimately up to the account executive, so you don’t want to put that much of their potential pay at risk.
Therefore, sales engineers are typically compensated with a lower leverage, with their base pay accounting for a much larger percentage than their variable.
Just as water runs downhill, salespeople will always do the activity that causes them to make the most money. So how to set their comp, at its heart, is really a philosophical question about what behaviors and activities your company is looking for.
One of the common knocks against salespeople, for better or worse, is that they’re “coin-operated,” and if you’re not paying them they’re not going to do the work. Whether that’s fair or not, it turns out to be really useful information.
Your comp plan should reflect the idea that the things you want your account executives (AEs) to do are exactly the things you’re going to pay them for. It’s an unhealthy setup when you tell a rep, “This is what you get paid for, and I also want you to do all these other things.”
You’re telling them to devote too much effort towards completing tasks that won’t benefit them.
The comp plan is as much a directive on their behavior as anything you ever instruct them to do. So what do you really want from your reps?
The common answer to this is that you want your reps to bring in a whole bunch of money and get paid a reasonable amount. That’s a total no-brainer.
But if you’re a fast-growing startup, what if you can only do one of those things? What’s more important? Dramatic topline revenue growth or bottomline control over your margins?
Early on, Segment realized that their most important goal was winning tons of deals. When they got their heads around that core goal, it changed the way they approached their comps. It was no longer about paying people a reasonable amount, but about opening doors.
If you can find a rep who wins $5 million in new business in new verticals where you have no idea how to sell your products, then what’s the problem with paying them $1 million? They’re creating a playbook for how to win deals that other reps will follow, they’re making the company money that you’d have no other way to make, and word of their huge pay package will spread among their friends and you’ll be hiring from a pool of other excellent reps.
As another example question, how important is it to you to get multi-year deals? If it’s really important, you have to comp for that or it won’t happen.
Not because people are coin-operated, but because if you pay people to do one thing and ask them to also emphasize others, you’re speaking with two mouths.
One thing that often gets lost in the sales comp shuffle is the time-cycle aspect. You want to align your sale cycle and comp plans to get the best effort from your reps.
If you have a relatively simple product in a well-known industry and a predictable sales cycle that is, say, six weeks long, then your comp cycle and evaluation should be monthly. Or at the worst, quarterly.
You also may have monthly bonuses, where everyone has a quota, but if they beat it, they get an additional accelerator (more on that later).
If you have a six month-long sale cycle and a product that isn’t quite ready for release (i.e. you’re not expecting your reps to be able to hit their numbers until a new product ships), then you’ll want a longer time horizon for evaluating and rewarding rep performance.
A single amazing quarter might be followed by a dud, so you wouldn’t want to pay out quarterly bonuses.
Accelerators and Decelerators
Common features in a plan are accelerators or decelerators.
Let’s say you have a rep who has a $100,000 base and variable pay, for an OTE of $200,000, and her quota for the year is $1 million of new revenue. That gives her a functional commission rate of 10%. You might say something like, “For every dollar you bring in above $1 million, your commission rate doubles to 20%.”
That would be an accelerator. As she gets into higher levels of performance, the rate at which she’s paid significantly increases.
By using accelerators, you’ll get people swinging for the fences. Instead of devising a plan to bring in $1 million by the end of the year, they’ll shoot to do that by May.
Some companies also do decelerators, in which they don’t promise a straight 10% on all revenue up to $1 million. They may actually underpay against the average up to $1 million, and gradually increase the rep into higher rates.
For example, the first $500,000 a rep brings in, he might not get any commission at all. Then gradually from $500,000 to $1 million, he gets 20% on average and that’s how he attains his $100,000 variable pay.
By using decelerators, you’re managing out your underperformers, reserving the real juicy stuff for the people who are bringing in the numbers. For those who are barely scraping by or worse, you won’t have to tell them to go. They’re going to have to figure out how they can get into the money — or they’re just going to walk.
4) Transitional Capability
Make sure that your comp plan today can smoothly transition into the comp plan you’ll want in the future.
For example, if you’re an early-stage company today that is willing to pay reps a ton of money to bring in revenue from new markets, what happens once your company “cracks the code” on how to effectively and repeatedly sell your product? You’ll want to hire more reps, but you can’t pay them all mountains of money or you’ll go out of business.
Keep in mind, the transition here is not that a great rep has inspired you want to hire many more reps. It’s that systemically, the company can now predictably and reliably generate sales.
Maybe you’ve had a major product release, won some key customer logos, or built an incredibly effective marketing team. In any case, you’re no longer desperate for the top-1 percentile reps, and can now sustainably grow the business with top-10 or top-15 percentile reps.
You still need really talented people, but not one-in-a-millions.
At this point there is no longer as much sense in paying huge compensation packages for doing a role that has become more routine and better understood. As Raphael told us, “Lewis and Clark deserve the credit that they’ve received for first crossing the U.S. The railroad crews that followed them also deserve credit, but they were not exactly explorers. Amtrak riders get no credit at all!”
As your sales organization starts to scale and become more mature, you cannot extend the incredibly generous pay packages to the entire team, nor should you, because simply winning deals is no longer a code to crack. But if you cut pay, your early stars will quit.
You also can’t pay new employees less than existing employees, since that’s a recipe for toxicity. In fact, if you paid the early reps an incredibly high OTE, you’re already stuck.
Any founder or sales leader needs a decent grounding in some of the softer mechanisms that make up sales compensation below the headlining base and variable numbers. These include mechanisms such as decelerators, accelerators, quotas, and MBOs. A good understanding of how to deploy these tools can make transitional growth less disruptive and lead to reduced attrition of early rockstar reps.
For example, if you have a rep you know can launch your business, lay it out like this: even though her OTE is $150,000, she can reasonably expect to smash her quota, get into accelerators, and make $500,000.
Later, when you bring reps on, they will still be on the $150,000 OTE plan, your rock star will still be there, and all that changes are the quotas and accelerators. People can still get these pay days, but quotas are higher and they must work a bit harder. All without a huge change to the structure.
If anyone out there is relatively new to sales compensation plans, talk to your peers and advisors. Warning: if you talk to your reps about their comp plans, they’re always going to complain!
You’ve got to make a clear path for your reps to make a ton of money. If you’re a VP of sales, it’s your job to richly reward stars for great performance, while staying aligned with the most important needs of the business.
Then you can have it all: revenue, scaling, expansion — and really happy reps.
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