How sales leaders can design an effective incentive compensation plan

In today’s changing business environment, firms are often challenged with designing and administering incentive compensation plans that are increasingly complex and support multiple organizational objectives—all while being fair, transparent, and compliant. 

Organizations that lack a properly designed incentive compensation plan face significant risks: demotivation, high turnover, and misalignment with strategic goals. Without effective incentives, salespeople's productivity and performance drop, and top talent leaves for better opportunities, raising costs. The absence of strong incentives can also foster a negative work culture, affecting overall morale and business performance. In short, without a well-crafted incentive plan, organizations jeopardize their success and long-term growth on multiple fronts. 

Cornerstones of effective comp plan design

Research shows that organizations with best-in-class incentive compensation plans for their sales teams see a 20% higher lead closure rate than industry averages (Source: Aberdeen Group). In addition to improving close rates and growing revenue, effective compensation plans can also mitigate costs by improving retention and reducing costs associated with sales representative attrition. To achieve this balance, firms must consider the three guiding principles that underpin any successful incentive compensation plan: strategic alignment, motivational perception, and fiscal responsibility.

Strategic alignment

Any incentive compensation plan must align with the company's strategic goals, guiding sales teams toward activities that contribute to organizational success. This alignment motivates employees to focus on the tasks and behaviors that drive business growth and success. It also helps to avoid the risk of rewarding activities that don't contribute toward—or even conflict with—the company's objectives. Ultimately, a strategically aligned compensation plan fosters a unified direction, enhancing overall organizational performance.  

Motivational perception

There are two components that together contribute to an incentive plan’s motivational perception: clarity and performance-based payouts.

• Clarity: There is a theory within the incentive compensation world that an optimally designed incentive plan can be explained on the back of a cocktail napkin. For an incentive plan to effectively drive the desired behaviors, it's crucial that the sales team understands which behaviors and results will impact their pay.
• Performance-based payouts: Incentive plans are most effective when sales teams are confident that exceeding their targets will yield additional rewards. By linking rewards directly to performance, it ensures alignment between individual efforts and the company's strategic objectives.

Fiscal responsibility

The focus of an incentive plan should not solely be on payouts; it's equally critical to ensure fiscal responsibility. An efficient incentive plan should motivate team members while keeping the cost of compensation in-line with expectations. From an on-target earnings (OTE) standpoint, this means aligning the pay level and pay mix to the organization's HR and talent strategies. Moreover, the incentive compensation should correlate with the company's performance. If the organization exceeds its targets, it can anticipate disbursing above-target compensation. On the flip side, if the organization doesn't meet its plan, the sales team's payout should reflect the miss accordingly.  

The blueprint to an effective plan

Crafting an incentive compensation plan is like piecing together a complex puzzle. Each piece, or component, is crucial and interconnected, together contributing to the plan’s effectiveness of driving the right results.

Pay level

Total cash compensation including base salary and at-risk pay

• Impact on plan effectiveness: Sets the competitive positioning of the company in attracting and retaining top sales talent. Proper pay levels ensure compensation is perceived as fair, adequate, and motivating employees to perform.

Pay mix

Percentage of pay that is base salary vs. at-risk (variable or incentive)

• Impact on plan effectiveness: Establishes the ratio of how much an individual’s pay level is comprised of fixed, base pay or, salary and variable, incentive pay. Higher variable pay leads to more pay at risk but provides greater opportunity for reward. Pay mix is largely driven by expected seller activity (e.g. new logo sales vs. account management) but can also consider product lifecycle, industry demand, and other factors.

Plan structure

Mechanism of calculation used to determine payout (e.g., commission, quota-based, etc.).

• Impact on plan effectiveness: Influences the motivation and fiscal responsibility of the plan by impacting how the sales team perceives their earning potential and the can draw the correlation between the company's results and the cost of compensation.

Pay curves

Relationship between earnings and performance (e.g., gates, slopes, accelerators, etc.)

• Impact on plan effectiveness: Affects the motivation of the plan by creating specific milestones that determine a sales representative’s payout; whether that be a gate before first dollar is paid or when sales representatives received accelerators.

Measures

Key performance indicators (KPIs) used to calculate payouts (e.g., revenue, growth, etc.)

• Impact on plan effectiveness: Directly ties compensation to measurable outcomes and achievements, ensuring KPIs are easily understood, influencing, and trackable. Selecting the right KPI measures ensures alignment with company goals and drives sales activities that contribute to strategic objectives.

Plan period

Period in which performance is measured and payouts calculated

• Impact on plan effectiveness: Ensures performance evaluation windows are designed with the typical length of a sales cycle in mind. By aligning plan measurement periods to sale cycle length, the plan can demonstrate to sellers that it has been designed for and accommodates typical selling motions, decision waiting periods, and can be meaningfully influenced by a seller on a period-to-period basis.

Payout frequency

How often team is paid (e.g., monthly, quarterly, etc.)

• Impact on plan effectiveness: Supports good plan design by providing expected, reliable, influenceable payouts to sellers on a regular basis while also minimizing risk of an overpay or drawback situation.

Additional benefits

Inclusion of additional components (e.g., contests, SPIFFs, etc.)

• Impact on plan effectiveness: Encourages in-year and short-term engagement from sellers while also supporting customer segment, product, or channel goals. Can also be used a testing ground for longer-term evolution of a SPIFF into a core plan component.

Ensuring a foolproof incentive plan

The potential levers of incentive compensation designs components outlined above provide firms with multiple levers to fine tune their plans—but they also provide multiple avenues of risk if not carefully managed. These risks can impact sales representative trust in the organization, not only potentially impairing seller performance and effectiveness but also inadvertently increasing attrition. 

A poorly designed incentive compensation plan can also encourage sales representatives to pursue activities and close deals that ultimately don’t support the firm’s overall strategic goals and can lead to worsening margins or missed plans. Organizations designing and implementing incentive compensation plans encounter a few common pitfalls:  

Misalignment with business goals

Incentive compensation plans constructed without the intent of supporting the organization’s growth or revenue objections. To avoid this risk, ensure that the firm’s targets are top of mind at the beginning of every incentive design discussion. 

Complexity over clarity

Incentive compensation plan designers often will include multiple plan measures, citing the importance of each measure to overall objectives. However, incorporating too many measures can lead sellers in multiple directions and create goal confusion. To create clarity, each incentive compensation plan measure should be no less than 10% of a seller’s OTE. 

One-size-fits-all approach

Oversimplifying plans in the name of administrative ease is common for growing organizations, who have yet to meaningfully differentiate between different sales teams. Customizing incentives for different sales roles ensures equitable motivation and maximizes each team member’s contributions. 

Inflexibility

The plan should allow for adjustments based on changing market conditions and business strategies. Fixed plans can quickly become outdated as market conditions and strategies evolve. Flexible plans allow adjustments to remain relevant and effective, aligning with changing business needs.

The optimal incentive compensation plan

An optimal incentive compensation plan is one that embodies the organization’s strategy, motivates its sales force, and upholds fiscal responsibility. By considering the unique needs of different sales roles and ensuring the plan is simple, clear, and directly tied to measurable outcomes, companies can fuel their growth engines effectively. Remember, the best incentive compensation plan is one that gets the sales team to wake up in the morning with a clear goal and the drive to achieve it. 

How to evaluate your plan

Using these principles, design components and common pitfalls, constructing an effective plan can still be a challenging task. Ensure your organization meets the best practices outlined above by reaching out to our team of experts at West Monroe.