Sales Commission Programs

Quick Summary: Paying sales reps for achieving sales targets is an accepted practice that requires careful design.

Abstract:

Revenue for enterprises or its equivalent for non-government organizations (NGOs) and government entities is the life blood of every organization.  Compensating sales reps or others that are responsible for generating revenue is a common and expected business practice.  Implementing a well-documented program that meets the specific requirements of the organization and is attractive to employees is critical to ensure that company and individual expectations are met or exceeded.  Many variations are used with probably no two programs containing identical provisions.

Virtually every company that has a direct sales force has a sales commission or incentive program. Even companies that do not have a direct sales program, or have an arrangement in which their sales reps are not paid a commission, most likely have some method of determining each rep’s performance.  Some programs are based on team performance, but most of the programs award individuals based on their own performance measured either against their peers or against some pre-established criteria.  There are probably almost as many program variations as there are companies that implement them.  There are far too many factors that can be considered to allow any one program to be applicable in all situations.  This article highlights some of the key issues that should be applicable to most programs.  One program variant that has been successfully used for several years by a number of companies has been included in Volume Eight of this collection.  A description of that program as well as a simple set of graphs and tables that illustrate how the program is implemented is included.  Below is a list of issues and observations that should be considered in developing a sales rep compensation plan.

  1. Sales compensation programs fall into two general categories, and each can contain some of the features of the other.
    1. The first variation compensates sales reps based on a percentage of the revenue they generate.  These programs are referred to as sales commission programs.  A commonly used variation of these programs is to pay no commissions until quarterly year-to-date or annual quota is achieved, and then pay a commission on all sales made above quot
    2. The second variation compensates sales reps with fixed payments associated with reaching certain sales targets.  Those targets may, for example, be revenue based, the sales of specific products, or sales to new customers.  Other criteria and various combinations can be used as well.
  2. As discussed in the article in this collection “Fair versus Equal,” the use of one standard sales commission rate (percent of revenue) is rarely appropriate.  Variations in territory, existing customer base, regionalized competition, bulk purchase contracts, and many other factors can place some sales reps at an unfair disadvantage.  A more appropriate arrangement is to establish a target commission amount for quota performance within each sales rep’s region. The resulting commission rate (commission amount divided by quota) will vary accordingly.  For example, Sales Rep X may have an annual target commission payment of $25,000 for achieving sales of $1,000,000.  Sales Rep Y with a larger and more mature collection of customers may have the same annual commission target, but may be expected to achieve $2,000,000 in sales.
  3. Although the term revenue is used to determine a sales rep’s commission, the actual financial metric may vary.  Instead of GAAP defined revenue, it could be the receipt of a binding commitment letter, a signed contract, the receipt of a down or full payment, the receipt of a processible order, the order shipment, system acceptance, or the payment in full for the product. Each company needs to carefully define the metric they intend to use.
  4. Avoid sales draws or prepaid commissions even with legally binding claw-back provisions which are rarely enforced.
  5. Consider including provisions that increase the commission rate (by as much as 50%) for sales made after a rep has reached their annual quota.  This provision acknowledges the fact that many company expenses are fixed and based on overall quota performance throughout the organization.  Sales above that level will generally be far more profitable, and those profits should be shared with the superior performers.
  6. Place no top end on the commissions that a sales rep could earn for normal sales.  Allow them to be or imagine to be the highest paid person in the company including the CEO.
  7. Pay sales commissions only once for any given order.  If multiple sales reps are involved, include pre-arrangements as to how the single commission will be allocated and paid.
  8. If any changes in territories or customers are made, resolve responsibilities and sales credit before the change goes into effect to avoid future conflicts; always document the arrangement in writing.
  9. The company needs to reserve the right to refuse any order that does not meet its generally accepted practices or capabilities, and make no or limited commission payments accordingly.
  10. Develop prior agreements for commissions associated with pre-paid multi-year orders and service contracts.  This can be very difficult and cause several unintended consequences. A separate article “Sales Commission for Periodic Sales” has been included in this collection and discusses many of the factors that need to be considered.
  11. Include provisions for recouping commissions when products are returned that can be directly attributed to the sales rep’s misleading claims or actions.
  12. Consider establishing special provisions, perhaps independent of the sales amount, for closing certain types of sales such as beta trials, new products, or joint development activities.
  13. Consider including certain non-recoupable quarterly commission payments to avoid the situation of sales occurring at year’s end while few orders are closed and revenue recognized during the year.  This technique will encourage sales reps to maintain year-to-date performance to help the company maintain acceptable cash flow.
  14. Consider establishing discount and special sales contract limits for sales with terms or conditions that are outside the normally expected terms that could adversely impact the company.
  15. Provide a sales commission plan written in plain English.  Avoid attempting to make it a legal document with obscure language.

To a sales rep, the above listing may appear to be unfair or draconian.  However, the list is intended to avoid future conflicts.  It follows the notion that good fences make good neighbors.  Setting expectations beforehand is a solid business practice.  All of us naturally become masters of whatever measurement system is used to measure our performance.  Sales eps, who by their very nature are always selling and positioning are certainly no exception.  A well-defined, written program available before the beginning of the measurement period will help to avoid misunderstandings later.

 

Article Number : 4.040306   

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