Designing Sales Compensation Plans So Everyone Wins
U.S. companies spend an estimated $800 billion on sales compensation annually. Ideally, the underlying compensation plans are designed to encourage behaviors that support business strategy; more often than not, however, they are at least somewhat misaligned with strategy, which itself is a moving target. More than 90 percent of companies change their sales compensation plans annually, with major redesigns occurring every five years. In this article, I explore one approach for making better sales compensation design choices and conclude with recommendations from the MAPI membership.
Compensating by Sales Cycle
As products and strategies change, so must sales organizations, and in turn their compensation plans. Sales organizations go through growth phases and need to be managed, measured, and compensated depending on where they are in that cycle. For example, it’s extremely difficult for the same sales force to be effective at selling high-growth products in high-growth markets while simultaneously selling low-growth products in low-growth markets. Just look at the challenges that the Leap Wireless sales force is having selling iPhones.
At a recent MAPI council meeting, David Cichelli of the Alexander Group presented a framework of a typical sales organization’s growth cycle (Figure 1). What Cichelli and his team have learned is that sales effectiveness solutions (including compensation) vary by growth rate, and thus compensation programs need to be configured with this cycle in mind. According to Cichelli, who expands upon the concept in his book The Sales Growth Imperative, sales management is “continually challenged to use new sales effectiveness solutions as the company’s maturity evolves.” Cichelli cautions against “using yesterday’s solutions to solve today’s problems.”
Most manufacturers have some products in one of the four phases of growth, and perhaps in multiple phases depending upon geography. The opportunity is to map where each business (or product line) is in the cycle, and then apply the appropriate sales tools. Here are some quick recommendations for modifying compensation plans:
- In Phase 1 (Start-Up), the emphasis is on persuasion selling, and therefore variable compensation should be aggressive.
- In Phase 2 (Volume Growth), the goal is revenue management: getting new customers, keeping customers, and launching new products. For this phase, the variable compensation plan should have a volume component, perhaps with a retention modifier.
- In Phase 3 (Re-Evaluation), price management is key: protecting the base, managing pricing, and reducing costs. Volume and price realization (or discounting) might be additional metrics in the compensation plan.
- In Phase 4 (Optimization), the goal is segmented growth: new value propositions, penetrating new markets, and specialization. The compensation metrics should be tailored to target these selling objectives.
Clearly, there is no silver bullet compensation solution, and companies need to consider which approach to take depending on a variety of factors. Put simply: what works today might not work tomorrow. “This means that so-called best practices are really situational solutions rather than proven, universal truths,” says Cichelli.
Advice from Fellow Manufacturers
Several MAPI members have presented case studies on how they’ve reinvented their sales compensation programs, and we’ve examined the issue several times in council surveys. Based on that library, here are some recommendations for ensuring that your compensation plans are as effective as possible:
- When changing compensation plans, sales will assume you’re taking something away. Focus messaging on total target compensation, and only later explain the mechanics.
- Define the roles and compensation of hunters (new business development) and farmers (account managers).
- Ensure that compensation is paid differently for persuasion vs. fulfillment sales.
- Sales is the most accountable workforce. Be careful not to overload them with administration.
- Around two-thirds of reps should hit quota. If you deviate much from this, forecasting is to blame. For many companies, sales targets amount to “Ready, Fire, Aim.”
- Don’t pay sales commissions if the new customer doesn’t pay. Use clawbacks if necessary. Only 17 percent of companies surveyed base compensation on orders (rather than payment).
- Compensation needs to take profitability into account, not just volume. Nearly half of manufacturers surveyed factor gross margin into payouts.
- When outlining sales compensation for emerging markets, be explicit with payment terms.
- When market conditions are unclear, consider abandoning annual sales plans in favor of horizons of 3-6 months.
We have a great example of a MAPI member company that has put several of these practices, and others, into action. When Siemens redesigned their incentive compensation system last year, they sought to strengthen the link between pay and performance, reward profitable sales, and simplify plans so that they were both easier to understand and more competitive with industry peers. The company spent six months on due diligence, defining roles, and testing assumptions. That upfront work yielded big dividends: volume is up 19 percent and sales productivity is up 22 percent.
What was the key to success for Siemens? According to Senior Vice President of Sales Tom Kopanski: “With any change in compensation, it’s important to be transparent. We wanted to make it as easy as possible for our reps to understand what they were going to see in their next paycheck.”
Having a robust communications strategy in place, even after the launch of the new compensation program, has also been critical to its success. “We have a steady drumbeat of communications around what our sales executives need to do to be successful. Our compensation plans are very well aligned to Siemens’ strategy, so when our sales teams win, Siemens wins, too.” MAPI members can access the full Siemens case study by clicking here (login required).
On August 6 in Chicago, MAPI is holding a one-day training session for manufacturers who want practical, research-driven advice on how your organization can design the most effective sales compensation plan possible. To encourage dialogue, attendance will be limited to 40 participants, and we expect to sell out quickly. Click here to learn more or register.