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By David J. Cichelli, Senior Vice President, The Alexander Group, Inc.

When designing a pay strategy, knowing the answers to seven key questions can make or break a sales compensation program. The effective design and administration of a sales plan ensures that target pay is aligned with performance, persuasiveness, marketing objectives and changing market conditions.

Sales compensation is a mission-critical pay program. No other pay program can claim the same degree of impact on sales revenue performance. It is a high-stake, high-visibility pay system that requires continuous focus and comprehensive design support.

As marketing and sales objectives change to stay competitive, sales management and compensation managers need to keep the sales incentive plans contemporary. Unfortunately, one or more sales compensation design riddles can sidetrack this process.

Listed below are seven of the most common sales compensation design riddles. The answers will keep your design efforts moving forward with minimal distractions.

Riddle #1: Should sales compensation payout amounts be unlimited?
Riddle #1 presents the most controversial of all sales compensation riddles. It belongs to a family of related questions:

• Should sales compensation pay be capped?
• Should sales personnel receive a fixed proportion of the revenue dollars?
• Why care how much money salespeople make, as long as company revenues and profits increase?
• Why do salespeople obtain extremely high pay for selling a product that others have designed, manufactured and shipped, but lack similar upside pay opportunities?

Solution: To answer this riddle, you need to first separate sales jobs into two categories. The first category of sales jobs is known as the seller/business model. These jobs include life insurance, stockbrokers, real-estate agents, mortgage brokers and merger and acquisition specialists. Membership in this category concedes that the company's unique business is, in fact, selling. For the most part, products are commodities -- successful selling is the variable that truly differentiates the company.

A convenient test for membership in this category is to assess "customer portability." If the sales force can take their customers with them when they leave, then the job belongs in the seller/business model. Pay for these jobs is uncapped and unlimited. They are paid a proportion of the revenue or profit dollars.

The second category is the seller/representative model. In this case, the salesperson acts as an employee-representative of the company and its products. Most sales jobs fall into this classification. The company manages payouts within a prescribed target pay range. Management uses market data to establish these amounts. Through careful incentive design and assignment of accurate quotas, the pay plan successfully can manage payouts within a preferred range -- without resorting to caps.

Riddle #2: How much target pay should be at risk?
This riddle often invokes numerous anecdotal stories favoring one view or another. Some support high base salaries as a portion of pay, while others believe in a low base salary component. Compelling arguments support both views. Plans featuring high base salary with low at-risk incentive pay are better because they drive loyalty, offer more control of pay and allow greater management flexibility. The opposing view favors a lower base salary with a higher at-risk incentive because these plans ensure variable costs, drive volume performance and are more motivational.

Solution: Fortunately, there is a simple answer to this riddle. The pay mix is the ratio of base salary to incentive at risk, expressed as a percent of the target pay. The shorthand format for expressing pay mix is: base/at-risk incentive. For example, an "80/20 plan" features 80 percent of the target pay in base salary and 20 percent of the target pay at-risk. The degree of persuasion in the sales job sets the pay mix. If the sales event relies on the persuasion skills of the seller (door-to-door encyclopedia sales, for example), then the base salary will be low and the at-risk portion will be significant.

However, if the company's product and service offering provide the rationale for the customer's purchase, then the persuasion role of the salesperson is less relevant and the base salary is higher, while the at-risk proportion is smaller. For business-to-business sales jobs in the United States, the average pay mix (base/at-risk incentive ratio) is 70/30. Again, the basic relationship follows this principle: more persuasion equates to a lower base salary; less persuasion equates to a higher base salary.

Riddle #3: How much upside earnings should be available for outstanding performance?
Some sales compensation designers often leave upside earnings opportunities to chance. A common mistake is to double the incentive rate when the salesperson achieves target performance. This questionable methodology easily can lead to under or overpayment.

Solution: Like target pay performance, the sales compensation designer needs to pre-establish upside pay levels for outstanding performance. Fortunately, we can use a simple multiplier of the at-risk portion to establish the outstanding pay level. Beginning with the mix (e.g. 70/30), take the at-risk portion (30) of the target compensation, multiply it by three and add the result to the base salary. This commonly used "triple" rule should give you a very close market approximation of the expected upside earnings potential for outstanding performance.

"Outstanding performance" is defined as the 90th percentile of performance. In some cases, this number will be 110 percent of goal and sometimes it might be 150 percent of goal, depending on how difficult it is to exceed goal. (In sales compensation jargon, this is known as "sales elasticity.")

Once you establish the upside earning potential (triple) and the outstanding performance level (90th percentile), you can calculate the correct formula that will produce outstanding pay for outstanding performance. Approximately 10 percent of the people will exceed this number (remember, they have no cap), but if the math has been done correctly, they will not exceed this amount by very much.

Riddle #4: How many measures should be in a sales compensation plan?
Selecting performance measures is one of the most important steps in developing focused sales compensation plans. Some plans try to measure too many things, while others are too simplistic and use too few measures.

Solution: As a rule of thumb, "use no more than three measures" in a sales compensation plan. A task force of business leaders (sales, marketing and finance) should pick measures for each sales plan. While the limit of three measures is arbitrary, it helps provide focus to the incentive plan design efforts. To help reduce the number of measures, eliminate the following types:

• Input measures that track activities leading to sales
• Non-persuasion measures such as compliance measures (paperwork, research, etc.)
• Corporate measures that sales personnel cannot influence.

Riddle #5: What percent of sales personnel should achieve target pay?
The number of sales personnel achieving goals dramatically affects payout amounts. If quotas are too easy, most everyone will achieve their goals and exceed target pay. If quotas are too hard, few people will achieve target pay levels. What is the right proportion between those exceeding goals and those failing to meet goals? In other words, "How difficult should quotas be?"

Solution: The following three systems need to work together: forecasting, quota allocation and sales compensation. The forecasting process develops the overall goal number for the next fiscal year. Sales need to participate in this process to ensure realistic numbers. The quota allocation process breaks down the forecast into individual goals for each salesperson. It is preferred that there is no over-assignment of quotas that exceed the forecast, nor "breakage" that leaves some fraction of the forecast number unassigned to sales resources.

Most companies establish performance scaling (i.e., difficulty of quotas) as follows: 60 percent to 70 percent of sales personnel should achieve and exceed their quota -- 30 percent to 40 percent should not. While this ratio causes a slight overpayment of the target compensation levels, the amount is minimal and offset by low performers earning little to no incentive.

Riddle #6: What causes sales compensation plans to fail?
Many organizations report that their sales incentive plans operate without problems -- most of the time. Yet, when compared to other pay programs, sales incentive plans have a much higher incidence of failure. Overpayments, underpayments, wrong behaviors, unexpected outcomes and overall frustration from field sales personnel are common symptoms of sales incentive plans.

Solution: Many reasons exist for failing sales incentives: questionable quotas, poor formula mechanics and broken administrative systems. One of the most common errors -- and often overlooked by sales compensation design specialists -- occurs in sales job design. Sales organizations continually need to realign their jobs with emerging and changing market conditions.

However, without effective buyer segmentation tools, sales organizations allow their sales jobs to become "blended" (too many dissimilar selling tasks), and "corrupted" (nonselling responsibilities encroaching into the sales job). The natural tendency is to attempt to resolve these job design errors with sales incentive plan "patches." The result is too many measures, attempting to reward too many dissimilar, non-productive activities. While the sales plan is blamed for these problems, the root cause is in erroneous sales job design.

Riddle #7: Who is responsible for the design of the sales compensation plan?
Most sales departments assume ownership of the sales compensation plan design. However, other departments often challenge this control. HR argues that sales compensation is an employee compensation plan that should comply with corporate compensation policies. Marketing wants to influence the sales compensation design to help achieve marketing objectives. Finance believes they should provide cost leadership to the plan design. Sometimes, senior management weighs into the design efforts with suggested design preferences.

Solution: Sales compensation is a sales management solution. As such, the sales department "owns" responsibility for the effective design and administration of the sales plan, but others must contribute to the design effort. By using a task force approach, HR can ensure target pay levels are consistent with market pay objectives. Marketing can ensure proper focus on products. Finance can provide the revenue, cost and profit objectives. And, yes, senior management can help provide leadership regarding business objectives.

Compensation managers should provide leadership to plan design efforts.

Onward
With the above solutions to these seven sales compensate design riddles, those responsible for sales compensation design can move forward with confidence and dispatch.

About the Author -- ACA faculty member David J. Cichelli is Senior Vice President of The Alexander Group Inc., a national sales and marketing consulting firm.

Editor's Note: To learn more about sales compensation, attend ACA's one-day seminar Sales Compensation Design -- Developing Next Year's Plan. David J. Cichelli will host all four offerings - New York on Sept. 8, Dallas (Irving) on Sept. 10, Chicago (Rosemont) on Sept. 22 and San Francisco (Millbrae) on Sept. 24.

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