Sales Compensation Plans from an Engineer turned CEO’s perspective

STOP reading if you have experience as a sales person, sales manager, or sales executive.  You probably know more than I do about the topic. 

Prior to my experiences as a CEO and independent director, I had no exposure to sales compensation plans or issues.  Over the course of leading four companies, and serving on a similar number of boards, I have seen a wide variety.

Quota bearing sales representatives (QBSR) tend to be much more comfortable with risk than engineers.  They probably wouldn’t be in the profession if they were not since 40% to 60% of their compensation is variable, tied to the achievement of results.  Whereas an engineer’s approach to variable compensation (bonuses in their case) is often to discount it, many QBSR’s count on achieving theirs and some even spend it before they have it (which can certainly provide an extra dose of motivation).

You know the business expression ‘you get what you measure’.  This is even more true for QBSR compensation and that is a good thing.  Back when I was a 22 year old systems engineer working for IBM, during the first business day of the new year, I was amazed to see all of the QBSR’s (many of whom were not noted for their studiousness), reading through the (literally) 300 page compensation plan that had just been issued for the new year.  Personally, I couldn’t think of anything more boring, but the compensation plans do have a significant effect on QBSR behavior, hopefully pointing them in the direction that best serves the company (although beware the law of unintended consequences when not structured correctly).

That 300 page plan stuck with me as an extreme example of complexity.  On the one hand, it is worthwhile to keep the plan as simple as possible, so heavy emphasis is put on the things that matter most to the company.  On the other hand, sometimes a too simple plan is suboptimal.  For example, paying QBSR’s only on total ACV sometimes leads to too much emphasis on  megadeals to the exclusion of signing a larger number of new customers (who in total might represent greater LTV than one or two megadeals).  There is no absolute right or wrong here, just keep in mind that a balance needs to be struck between simplicity and having key company goals represented in the plan.

I know I said that QBSR’s were very motivated by compensation and that is true.  Nevertheless, it was important for me to learn and appreciate the difference between quota and pay.  Quota and pay can differ in that some aspects of a compensation plan might offer payments for achievements that do not count towards quota.  For example, sometimes ACV achievement is all that is measured for quota attainment, but QBSR’s are also paid for contracted Services revenue (often at a lower percentage than ACV).  Since QBSR’s spend their careers in environments where failure to meet quota is often followed by job loss and, furthermore, percent quota attainment is publicized in a highly visible and competitive way, the motivation to attain quota credit can sometimes surpass the motivation to earn more money.

In a perfect world, the sales compensation plan would precisely measure the LTV of a new customer and reward the QBSR based upon higher LTV.  In most cases, this gets too complex to measure and put into a compensation plan.  However, it is useful to think of proxies for LTV that can move a plan in that direction.  For example, in enterprise situations where price negotiation with customers is intense, you could pay a QBSR more for negotiating a price that is a higher percentage of the list price than the norm.  Or you could pay more for a longer term contract (particularly if you have churn or retention risks).  Or you could pay more for sales into accounts with large ‘land and expand’ potential.

How to think about the overall sales force’s quota attainment and pay at the end of the year?  An aspect that varies between companies is the expected number of new customers to be signed to achieve quota and the standard deviation in deal size.  (I am speaking only of enterprise sales situations.)  In situations where the average quota attaining QBSR closes a small number of deals (2-4), there will be a large standard deviation in quota attainment among the QBSR’s.  I have seen situations where the top performing QBSR was over 500% of quota.  In this environment, it is OK (preferable in my opinion) for a top performing QBSR to earn a lot of money.  If the top performing QBSR earns over $1M (more than top sales management and more than the CEO), it is a good thing for motivating other QBSR’s and as a recruiting tool as you ramp up the sales force.  I am strong believer in an uncapped compensation plan with aggressive accelerators (perhaps a QBSR over 200% of quota might be earning a commission rate two or three times as large as someone below quota).  On the other hand, if the average quota attaining QBSR is going to close 10-15 deals, the standard deviation might be much lower, with the top performing QBSR much closer to 200%.  In this type of situation the pay distribution will be much narrower with the top performer making more like 2X target full year compensation as opposed to 3X-4X in the other scenario.

Another thing to evaluate at year end is the portion of the sales force that achieves quota.  In a year where the total ACV achievement of the sales organization is on target, the percentage of QBSR’s attaining quota should be around 50%.  If you are in the few deal environment, perhaps it will be a bit less and if you are in the many deal environment it might be a bit more.  What would be very important to understand is a situation where the overall ACV target was achieved but only a small percentage of QBSR’s achieved quota.  This could be indicative of an anomaly in your sales ramp up where the market is not really yet ripe for your offering and the goal was achieved primarily based upon a small number of very large deals (a situation that will be hard to predict and replicate in future years).  It could also be indicative of the need for much more investment in sales tools and training to bring up the performance of the non-superstar QBSR’s.  At the end of the day, no matter how much everyone talks about hiring only A+ players, as you grow and ramp up your sales force, a significant portion of your success will also come from making B players (who should also be delivering a high LTV/CAC ratio) as productive as possible, and retaining them for a number of years instead of constantly being in the mode of ramping up new hires to see if they can become A+ players.


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