The estimated reading time for this post is 12 minutes
Your sales department is vital to your bottom line and long-term growth. While keeping your salespeople motivated is a constant flywheel, deciding what compensation package to offer them can prove to be a delicate balancing act.
Small business owners and founders should examine and refine compensation paradigms for their sales teams, going into 2023 so that everyone wins and can prepare for the upcoming year.
In this post, I hope to tackle these questions and hope it will give you some insight to help you make your own decisions on a few of the most common compensation models
Option 1: Salary Only
It’s interesting to note that nearly every other part of a business, a salaried wage is commonplace, but for sales teams are not paid using this structure most of the time. Just like your other employees, under a salaried structure, you decide how much you pay your sales team members and the basis thereof. Regardless of how little or how much they sell, their direct deposit is the same amount each month. The implicit understanding is that if they don’t meet their new business revenue targets, they’re likely not going to be employed for very long
This structure is uncommon for most sales teams. Because the current thinking is that without a commission, your sales reps are typically less motivated to go beyond where you’d like them to go. Typically, when they hit their target with this structure they usually go into a mode of relaxation, instead of driving full speed to the next deal.
Say, you worked in HR as a senior manager and someone on your team is NOT executing to their highest potential, you would likely choose to review the barriers to performance, and then if they were unable to remediate their performance, you’d terminate their employment. By the same token, it would be the same for sales teams using this compensation method. If they don’t perform, they remediate, or they’re out. In this way your sales team is treated like all other employees in your organization.
Option 2: Salary Plus Commission
This compensation structure is the most common found in organizations today. Under this framework each sales team member receives a set base salary (usually a range based on experience) and commissions based on their sales performance. Using this compensation structure offers the advantage of stability while motivating them to maximize their performance.
The base payment provides a steady income that enables team members to focus on mid to long-term objectives instead of seeking short-term abnormal behaviors. Depending on the stage of their lives, this base salary will likely cover most, if not all, of their basic living expenses and the commissions will provide them additional “lifestyle” enhancements.
For veteran salespeople who may have families and mouths to feed, or while introducing a new technology or company into the market (sometimes called “pioneering”), a base salary will support them in getting your message out to the market.
For the business owner, providing a base salary plus commission will result in increased sales operations and customer acquisition costs alongside cash constraints. (This includes items such as payroll taxes and benefits expenses relating to the salary).
Option 3: Commission-Only
This is a compensation plan where a business pays salespeople commission only on what they sell. There is no base salary, so this is truly an “‘eat what you kill” sales environment. Many believe that this plan is ideal to motivate salespeople to work harder to find deals, sell more effectively and convert sales.
Under this model, the thinking is that salespeople who are driven by income (aren’t we all?), typically go after prospects, and possess more motivation-fueled vigor in order to convert sales because their compensation is directly connected to their activities.
The highest performing reps find this compensation method very appealing because, when structured correctly, they have unlimited earning potential. The potential to earn high commissions is great when they know that the only way they make money is by making sales.
Thus, high performers will optimize their activities to source and capture the best and biggest deals by making those extra calls and working those longer hours. You can be certain that your sales team will go the extra mile to think Out-of-the-Box on how to make more sales because their livelihood depends on it.
In theory, this type of compensation can be the most attractive for highly motivated reps because it offers several benefits that should directly appeal to them.
- The adrenaline rush that every sale gives them, knowing it is tied to income.
- Large commission payouts signal to the rest of the team that you pay for performance
- If a Salesperson is extremely talented, he knows that he’ll be earning more than his peers who also make a salary. The more sales they make, the more they will earn compared to their less motivated peers.
However, this compensation method could also present great challenges for both organizations and reps.
Unpredictable Expenses for a Business
If your business provides payment terms to your customers, then your compensation model should be aligned with your billing practices. There will be an imbalance in net income and compensation if the business pays commissions to their salespeople immediately after the sales but does not receive payment for them for some time afterwards. Some Salespeople could also worry about the erratic nature of such a compensation plan.
Income Fluctuation for Salespeople
A straight commission plan lends itself to the possibility of dramatic monthly swings in income, resulting in earning fluctuations. Depending on the market they serve, salespeople might experience sizable changes. These kinds of variations could make accounting and budgeting for the future more challenging. This would cause instability in the personal life of your salespeople. In order to successfully plan for the volatility of their income and address these variations, employees must talk with a financial professional such as an accountant about how to manage their finances.
Nonaligned sales practices
With straight commission compensation plans, lies the possibility that salespeople can become overly aggressive in their pursuit of new business. These pursuits may run counter to your corporate culture or values. So while this approach might boost sales in the short term, it might also drive off customers who are taken aback and offended by these increased efforts.
Sales development can take some time. Building a sales pipeline is work. And the work takes time. Only customers who resolutely trust their salespeople will make a purchase, and developing that trust takes effort. As a result, many sales professionals are unable to accept a position with a straight commission structure, because even though the earning potential is limitless, they urgently need cash for necessities.
Exogenous market forces may cause even your highest performers to hit a performance slump for a quarter or two and/or extend your sales cycle (remember the first few quarters of the COVID pandemic?). If such events occur, then these team members may start looking around for someplace else to hang their hat, as a result, as the business owner, you must provide systems that keep performance and morale high during such events and periods
If you choose a commission only compensation model (and there are plenty of industries who do so), then you, as the business owner or sales leader, need to be prepared to provide extensive support, material, and training to maintain peak performance.
You’ll also need to get better at attracting and recruiting team members for this environment’s compensation model. As such you can easily fall into the “grey-haired” experience trap
For enterprises whose growth driver is sales lead (SLG), the advantage of this compensation structure is that you only pay for sales that have been converted. In this way, most of the time you do not incur compensation costs unless you capture sales revenue. While the actual commission rates can be substantial (40 to 50% of first year billing) business owners and sales leaders can control their labor costs more effectively and ensure that their selling efficiency is maximized by the commission structure.
However, raising the bar for each level of sales goals provides extra motivation. Reaching the level is an added challenge and as we all know, salespeople love a challenge, especially when it brings them more earnings.
Create a pay structure that rewards account growth by ensuring that the compensation plan is clear and detailed.
Option 4: Tiered Commission
Below is an example of a tiered commission structure. In this example, your sales reps would earn a rate of 10% for every deal they make until a 75,000 target is reached. Once that is reached, their commission rate would jump to 12% until they reach 125K in sales and so forth.
Advantages of this structure to reach your business goals encourages your sales team to drive forward in closing more deals even after reaching their targets.
This structure has the added incentive of having an uncapped earnings potential for sales revenues in excess of $200,000.
Some of the downsides of this structure are:
- Payroll will fluctuate as your sales team advances beyond their quotas.
- This structure may not relate to the actual effort that your team member actualized on the transaction – they may have been referred in late and just “closed” it out
- Sales agents will do their best to “game” their compensation based upon the structure, this is especially true as you approach a quarter or year end.
ALWAYS DELIVER ON YOUR COMP PLAN
NO matter the compensation method you choose (and trust us there are many more) it’s critical that businesses are prepared to meet their compensation obligations. I’ve met many business owners who’ve told me that they’re more than happy to write big checks to salespeople, but when the time comes, their CFO finds a way to cut the number somewhere below the salesperson’s expectation.
This is the single fastest way to lose your entire sales team. So, when you create a compensation plan, ensure that your business can meet the financial requirements.
In this regard, if you don’t know if you can afford a compensation structure, then I recommend you grab time with your finance leader and model out how any compensation plan has an impact on the business… You’ll likely discover something about your current and proposed Customer Acquisition Cost (CAC for short), that creates more insightful questions.
In this post I’ve covered some of the most popular sales compensation packages used by businesses to compensate their sales teams as well as some advantages and disadvantages.
There are other structures that we will cover in future posts.
Regardless of the method you’ve chosen, you need to ensure that the compensation plan fits your long-term objectives.
From what I’ve seen work well over the past few years, operating sales teams for small businesses in a variety of verticals, the best way for an established business to start is with an optimal base salary plus commission structure with accelerators and refinement as needed.
For Emerging Technology companies or those breaking into a new industry/geography/focus, I prefer the tiered commission approach as it recognizes that there will be some periods where you’ll be pioneering the market and then as penetration improves, you’ll reward high performers with increasing levels of uncapped variable compensation.
Which one is best for you? The answer to that burning question depends on a number of factors, some of which we have gone over here and others you need to decide for yourself. I hope this post can inch you closer to deciding on which to use for your business.