Variable pay in sales compensation and all you need to know about it
30 March 2022
Variable pay in sales compensation and all you need to know about it
What is incentive pay? What are the types of sales compensation? What do employees’ salaries look like when they are performance-related? When can we use this form of payment? Is it an appropriate solution for your company? What are the payment structures for mixed salaries? What are the types of pay for sales reps? How does the incentive compensation plan work? We will try to answer all these and a few other questions in today’s article.
What is sales compensation strategy?
Sales compensation strategy is an action plan which, on the one hand, is aimed at increasing the effectiveness of the sales reps operation, and on the other – as with every activity of a company – increasing revenues. This strategy, when well prepared, should include all the details of sales reps’ earnings, such as base salary, sales commission, and any other cash or non-monetary benefits that may motivate the team.
It is a well-known practice to use mix pay, especially in sales. This means sales reps’ earnings consists of two parts: a fixed salary and a variable part. The employee’s sales performance determines the variable part of the salary. When an employee reaches the sales targets set for a given period, sales compensation is paid as a type of bonus, incentive, or commission. Contrary to the basic salary, which is fixed and paid irrespective of whether the employees achieve their and the company’s goals at the given time.
Sales compensation plan:
Sales compensation plans are a common solution in sales teams for several reasons. A commission plan is probably the most popular of all the incentive pay options. How does it work?
What is a sales compensation plan?
Sales compensation plans can take various forms and structures depending on the organization’s goals, industry, and specific sales roles. The idea of a compensation plan is simple: when hiring a sales rep, the employer informs the employee that they will earn a base salary, and have the possibility to increase the total remuneration thanks to the sales compensation. The more you sell, the more you earn. Sometimes, an employer offers only sales revenue, without any base salary.
Sales compensation program
The sales compensation structure must be set at an adequate level adjusted to the difficulty of the sales process. For example, selling food is – let’s face it – not difficult – in every city, there is a large number of markets and small local shops that are willing to cooperate with sales reps. In this case, the sales reps can systematically make deals. The complete opposite will be luxurious, exclusive items and services that only a narrow group of people can afford. For example, luxury yachts. It takes longer to reach the potential customer and the decision-making process may take much longer. Hence, there will be fewer transactions, and salary commissions will be much higher.
If the sales objectives are set too low in comparison to the challenges and complexities of the sales process, it can demotivate sales representatives and hinder their willingness to go the extra mile. Conversely, if the compensation is disproportionately high for a relatively simple sales process, it can strain the company’s financial resources and erode profitability.
A well- designed sales compensation plan makes sure that the sales team is rewarded fairly for their efforts while maintaining the company’s financial sustainability. To achieve this equilibrium, organizations must thoroughly analyse their industry norms, market conditions, and the unique demands of their sales reps to design sales compensation plans that not only attract top talent but also drive sustainable growth and success.
Another example of a financial reward in a sales compensation plan that is given to sales reps in addition to their regular salary, can be a bonus. A performance-based bonus is an extra compensation granted to a sales rep as a reward for reaching pre-established business goals and benchmarks.
What is a bonus in a sales compensation plan?
A bonus in sales compensation serves as an additional incentive to recognize and reward the exceptional performances of sales reps. It’s an extra boost beyond the base salary and commission, designed for specific sales rep behaviours to go above and beyond in achieving their sales targets. Importantly, a bonus is typically not intended to be the sole or primary source of income for salespeople. Instead, it complements their earnings, providing an extra layer of recognition and financial reward for outstanding results.
What is a bonus structure?
A bonus is defined as a supplement to the base salary. Contrary to a commission plan, it cannot be the sole source of an employee’s income. Depending on the bonus type, there are different rules to grant it.
Types of bonuses
Discretionary bonuses are typically not guaranteed and are awarded at the employer’s discretion, often as a reward for exceptional performances, contributions, or other factors that the employer deems worthy of recognition. These bonuses are not usually outlined in employment contracts or predetermined by a formula, making them more flexible in nature. Employers can choose when and to whom they grant discretionary bonuses based on individual or team achievements, company profitability, or other qualitative criteria.
Regulatory bonuses, also known as contractual or guaranteed bonuses, are typically outlined in an employment contract or agreement. These bonuses are predetermined and often linked to specific performance metrics, such as achieving sales targets, meeting project milestones, or adhering to certain regulatory requirements. Unlike discretionary bonuses, regulatory bonuses are typically considered an integral part of an employee’s compensation package and are expected to be paid if the specified conditions are met.
On the other hand, the rules for granting regulatory bonuses must be strictly specified previously in the company’s internal regulations. What does that mean? Firstly, the employer needs to define specific criteria that must be met by employees to receive bonuses. The regulations should also contain information on the amount of the bonus, as well as the rules and frequency of awarding employees. At the same time, when the sales reps or sales team meet all the criteria, they have the right to demand the payment of the bonus. If necessary – even in court.
Management by Objectives
Management by Objectives (MBO) is a management approach and process that focuses on setting clear and measurable objectives or goals for individuals and teams within an organization. The MBO concept was popularized by management theorist Peter Drucker in his 1954 book “The Practice of Management.” The fundamental idea behind MBO is to align organizational goals with individual and team performance. This method builds a coherent set of goals for all teams and employees and for the evaluation of the performance. The sales management and the sales team are to agree on how and when to achieve business goals. In this model, sales managers are advisers rather than bosses.
Where to implement MBO?
Management by objectives can be implemented in companies or other businesses where the aim is achieving satisfactory results, but not necessarily financial benefits. Therefore, it can be used in public institutions, foundations, associations, etc. This method is considered to be highly effective in achieving both the strategic and operational goals of the business.
From this point of view, the key is to adopt an adequate goal and the realization of it. Usually, the supervisor has a moderating and controlling role.
Subordinates are accountable for the effects of the work as part of the desired results. The settled goal should be a challenge for the employee, but at the same time, it must be possible to achieve.
Management by goals helps employees set individual goals for development, and thanks to this development, there is a possibility for incentive pay. This is a popular way for employees who are not in the sales department or other commission-free employees. Goals are usually set by individual employees together with their supervisors and show how they can contribute to their role and/or go beyond their day-to-day responsibilities. Often, MBOs encourage collaboration and adopt innovative, creative ideas to help the company achieve its goals.
How to implement a sales compensation plan
Money motivates, therefore commission plans should effectively motivate sales reps to successfully close deals. By rewarding or paying for your representative’s performance, you establish a direct link between performance and compensation, which is one of the best methods companies can use to motivate sales teams and achieve corporate goals.
Sales compensation plans motivate sales reps
Variable pay is an amazing motivational tool, but it may not be the best idea when introduced without proper implementation and selection of commissions. Remember: if you rely too much on incentive payments, sales reps get a lot of individuality and the ability to manage them is out of your hands. On the other hand, too little variable pay for performance and a high base salary can cause sales representatives to not be inspired to work and achieve their goals.
Tips for effective sales compensation management:
Level of control over the sale
If your sales team uses a lot of help from other departments, or positioning and marketing are responsible for a large part of sales performance in your company, the salesperson’s salary commission should be lower than in cases when only the sales team works to achieve company goals.
Basing the employee’s income on the results of the entire team
Sales representatives should only be responsible for activities that they can control themselves. Lowering the base salary or salary commission of the best sales representative because the team did not reach the revenue targets may be seen as unfair and lead to them leaving for a competitor. Adjust sales compensation plans to the sales reps’ abilities
Roles in sales teams often require specification of the level of variable pay. For example, variable pay is higher when you have more control over the results, so an account executive tends to have the highest variable pay level compared to sales team members because they have a direct impact on the closure of the transaction.
Adjust the sales compensation plan to the role
Your team is made up of different people and their responsibilities vary. Not all sales roles are the same, so variable compensation should be based on the sales rep’s specific responsibility. While everyone has the same overarching goals, not all have the same responsibilities and decision-making powers. Role-based remuneration helps to improve the strengths of each position on the sales team, motivate each sales rep more effectively, and base rewards on activities and indicators that they can influence on a daily basis. As a result, the team is motivated, committed, and inspired to achieve new business goals.
The impact of mixed pay on the employee and the company
Prospering companies are well aware of the benefits of sales incentives and sales compensation plans. Therefore, companies strive to maintain a competitive salary (base salary and commission) in order to minimize the turnover of good sales reps.
The most important thing in a sales compensation plan’s creation is balance. You need to motivate your sales team and guide the sales reps’ behavior, but you also need to design your sales compensation plan to ultimately achieve your sales revenue and goals and increase your company’s profitability.