Learn all you need to know about the most common types of sales compensation plans: base salary plus commission, commission only, base salary plus bonus, gross margin commission, straight-line commission, and territory volume commission. Also, find out the four best practices for creating your own sales compensation plan.
According to Gartner, only 24% of surveyed salespeople find it easy to calculate their total variable compensation. That’s less than 1 in 4 reps!
This means that most companies tend to unnecessarily overcomplicate their sales compensation plans.
The secret to setting a good sales comp plan is to keep things simple and fair. Simple enough for your reps to calculate commissions and forecast earnings without too much hassle. And fair enough that your reps don’t feel the need to take their talent elsewhere — especially the good ones.
In this blog, we’ll look at the 6 most common types of sales compensation plans and the benefits of a solid comp plan. We’ll also cover some best practices you can follow to create your own plan.
First things first, though …
What is a Sales Compensation Plan?
A sales compensation plan is a formal document that outlines compensation i.e., when and how much a company will pay its salespeople. Each team member’s compensation plan is based on their role and experience, as well as other factors like the company’s product-market fit and type of market (mature or emerging).
A comp plan is an officially binding document and contains both the company spokesperson (often the sales VP) and the rep’s signatures.
Moreover, a sales compensation plan is usually released at the start of the year. It includes key figures such as quotas, on-target earnings (OTEs), base pay, commission rates, bonuses, and additional clauses like clawbacks, draws, splits, etc.
But how does a comp plan help?
Here are some key benefits of a sales compensation plan:
- Provides structure within the team by defining clear goals.
- Aligns individual efforts with company objectives.
- Ensures fair wages by linking pay levels to performance.
- Increases sales productivity by boosting employee morale.
Key Types of Sales Compensation Plans
There are a variety of sales compensation plans to choose from. But not all of them are used equally often. Some are quite common, while others suit certain business models only.
Let’s take a detailed look at the 6 most widely used plans:
Base salary plus commission
As the name suggests, the base salary plus commission plan includes a base salary (fixed component) and a commission (variable component).
Base salary plus commission is by far the most common type of sales comp plan. And for some pretty good reasons.
One, the base component offers reps some much-welcome income stability. While this is an asset in any job, it means a lot more in the world of sales where hard work doesn’t always pay off. Two, the variable component gives reps a reason to go that extra mile when trying to close deals.
Lastly, the limited variability in pay packages (since a majority of the rep’s compensation is fixed) allows companies to strategize better and budget smarter.
Commission only
The no-nonsense plan. You sell, you earn. You don’t sell, you don’t. It’s that simple!
The commission-only plan is best suited for companies looking to hire ambitious go-getters who like to bet on themselves. That’s because this plan offers some of the highest commission rates out there — up to a whopping 45% in certain industries.
Commission-only plans are great at separating the wheat from the chaff when it comes to your reps. They also help reduce risk since you only pay your reps for what they sell.
Even so, these plans are far from the norm. Why?
A few reasons:
- Predicting expenses and sticking to budgets becomes near impossible since there’s no way of knowing how much you’ll be spending on commissions each month.
- Attracting premium talent becomes a challenge since not all top salesmen like to take risks. Some like the cushion that comes with a cushy base pay.
- The plan’s high-risk-high-reward nature can lead to high turnover, low rep morale, and weak brand loyalty.
Base salary plus bonus
This plan includes a fixed base salary and a fixed bonus amount. While the salary is paid irrespective of performance, the bonus is only paid if the rep hits quota.
For example, Aston is a salesman at a department store and his base salary is $30,000.
He stands to earn an additional $15,000 in bonus if he sells $200,000 worth of goods in a year. If he sells anything less than that, he will not earn any bonus. Anything more, and he will still earn $15,000.
If you know how many of your reps are likely to hit quota, this plan helps you to budget like a pro since you can predict salary expenses with great accuracy.
However, the biggest drawback with this plan is that once your reps hit quota, they will have absolutely no incentive (pun intended) to sell more.
Gross margin commission
Most sales comp plans focus on revenue. But the gross margin commission plan focuses on profit margins.
Let’s look at an example.
Anne and Mark work at a consumer goods store that operates on the gross margin commission structure. Anne sells a television worth $2,000 while Mark sells a fridge worth $1,500.
Now, ordinarily, Anne would earn a higher commission since she sold the more expensive product. But the profit margin on the television was $300, while that on the fridge was $500.
Since Mark’s profit margin was higher, he will earn a higher commission in this case.
The greatest benefit of a gross margin commission plan is that it discourages reps from offering too many discounts since that will eat into their own commissions. These plans also help companies push sales of high-margin products.
On the other hand, this plan encourages reps to focus on high-margin items only. That could backfire for companies looking for a well-rounded sales portfolio where all products are selling well.
Straight-line commission
Straight-line commission plans bear a direct link between commission and quota.
How?
If a rep reaches 75% of the quota, they will earn 75% of their commission. And if the rep hits 130% of the quota, they will earn 130% of their commission.
Calculating commissions for this plan is super easy. Plus, your top performers will always stay motivated since there’s no limit on how much they can earn.
That said, there are certain complications to consider.
If you’re paying base as well (which is most likely with these plans) your underperforming reps might be perfectly happy hitting 70-80% of their quota.
Consequently, they’ll always earn 70-80% of their commission and never worry about reaching their full potential. Good for them … not so good for you.
Then there’s the budgeting issue.
Since this plan is effectively an uncapped commission, you might find yourself in a sticky situation if you’re working on a tight budget. Your reps could have an exceptional selling month. Or market fluctuations could result in a flurry of new customers your reps didn’t have to work very hard to close.
Territory volume commission
This is the ideal plan for reps working in teams that cover different sales territories.
Let’s consider Team A for this example. They have 4 reps. Each of them has a base salary of $40,000.
Last month, Team A sold $600,000 worth of goods. At 10%, that works out to $60,000 in total commission. The $60,000 is split equally between all four members, irrespective of how much they each sold.
So in effect, each Team A member earned $55,000 ($40,000 + $15,000) last month.
This plan clearly prioritizes teamwork and is a great fit for large organizations that have a presence in multiple cities or countries.
However, this works only if you have team players. Everyone on the team needs to be united by a common goal and also have similar selling skills. Otherwise, you might end up with your top sellers constantly pulling the weight of your underperformers — leading to a blow-up.
Best Practices for Creating a Sales Compensation Plan
Here are four proven tips you can use to create your own sales compensation plan:
Set sales compensation plan goals
Your sales compensation plan will only work if you know exactly what goals you want to achieve.
To figure that out, ask some questions like:
- Are you looking to improve cash flows? Or reduce churn?
- Do you want to increase your annual contract value (ACV)?
- Want to boost sales of certain products over others?
Once you have clarity on your goals, you can create a sales comp plan that will actually help you achieve those goals. Be it targeting a particular customer or business segment, or focusing on certain products and services, you’ll drive the right sales behaviors.
Set realistic quotas
Has your entire team been hitting their quotas lately?
If yes, that means your quotas are probably too low. On the flip side, if less than 60% of your team has been hitting quota, your quotas are likely too high.
That’s why, when setting quotas, it’s good to be aggressive but you also need to be realistic. The best way to set fair quotas is to look at your team’s past performances and see how well or poorly they performed.
Find that midway magic point, and your sales comp plan will be one step closer to yielding the results you need.
Choose the right compensation plan
This one goes without saying, but too often companies choose the wrong comp plan and then wonder where things went wrong.
If you’re not sure what the right plan for your team might be, ask yourself:
- Which comp plans are my competitors using?
- What sort of salespeople do I have — aggressive, conservative, or somewhere in the middle?
- Which plan will best complement my product portfolio?
- What kind of capital am I working with?
- What is the revenue focus? New logo acquisition or customer retention?
- Is this a greenfield market for us?
- Should I cap commissions for new products?
Review your comp plan
Markets are forever changing.
A plan that works today might not do so well tomorrow. Even if your sales comp plan is generating excellent results, you mustn’t take things for granted.
To ensure your reps always stay happy and motivated, review your plan as often as possible. For instance, check whether the achievements and payouts are in line with the business goals you set out at the start.
Try to make the changes that need to be made, do away with tactics that aren’t working, and double down on those that are. It’s the only way your plan will stay relevant and successful in today’s rapidly evolving marketplace.
Wrapping Up
Sales compensation is a game of constant trial and error. There is no one right way to do things, and there never will be.
Go through the plans mentioned above and pick what suits you best. And don’t forget to use the best practices to come up with the right plan for your salesforce.
Where you go from there will depend on how much attention you pay as you go along, and how quickly you adapt to different situations.
