entrepreneurshipresource center

The Resource Center has all the info you'll need From content to user feedback, the resource center has the information you need for every level of the entrepreneurial process.

Turning Sales Compensation On Its Head

Townsend Wardlaw, Founder and Managing Partner, Three Value Logic Sales Institute

It sounds like a radical idea – throwing out the traditional view of compensation plans as a motivational tool that ultimately helps sales reps attain company revenue goals while outlining the associated commissions or bonuses due them. But the reality is that on a day-to-day basis we at Three Value Logic Sales Institute (3VL) believe the base-plus-commission formula does very little to drive individual behavior toward those goals (see Figure 1 below). However, what the comp plan can do if structured appropriately, is mitigate the risk of spending money on opportunities and resources that fail, thereby protecting the company’s precious cash assets.

Most sales leaders are familiar with the concept of a sales pipeline or funnel. However, few acknowledge the sales funnel represents an attempt to ensure the consistent and predictable failure of opportunities over time. At the individual opportunity and/or resource level, we believe it is impossible to accurately predict the probability of success or failure. Stated simply, statistics and ratios are meaningless when applied to a single data point (one sales resource or one deal). In my work, I often say, “you cannot control (or even predict) which opportunities you will win. You can only choose how much time and effort you expend losing.”

As such, our compensation model consists of three basic elements: 1) transferring more of the risk associated with generating revenue onto the sales associate; 2) sharing resources across clients; and 3) tying a portion of base salary to specific and measurable events that positively impact revenue.

Here’s how it works.

Our Resource and Motivation Model

Part I: Re-Align Risk and Compensation. At its simplest, our compensation model represents a conscious effort to transfer more of the risks associated with generating revenue onto the sales associate. This is by no means a one-way street, and the goal is better alignment between company and individual for both risk and reward. In traditional models, a relatively high base salary is offset by small commission factors – in the majority of cases 2 to 5 percent of gross revenues. In our world, base salaries are relatively low but commissions run 10 to 20 percent of gross revenues.

Associating the majority of compensation with measurable results, of course, makes it impossible to attract sales talent who are accustomed to six-figure base salaries and six to nine months for acclimatization. Since the availability of appropriate resources is limited, our company develops and trains its own sales associates from the ground up, developing the necessary skills and an understanding of how those skills connect to performance and results.

Part II: Distribute Resource Risk. For me, the notion that any sales person spends forty hours per week at full efficiency is ludicrous. Similarly, the concept of putting all your eggs in the basket of one “star player” has always seemed like a bad idea. In our environment, no individual works on just one account and no account is supported by one resource. Instead, resources are shared across clients with the expectation that one-third to one-half of an individual’s time is spent on each client. The goal is to extract the best work on each project. This approach benefits our resources by allowing them to assemble a portfolio of opportunities across which to manage their individual risk.

Because base compensation reflects the shared nature of the resource, our company can deploy multiple resources within that client for the same cash cost of a single sales person, thereby avoiding a single point of failure within any client. Because our business supports multiple clients, it is relatively simple to pursue a shared resource model. In a more traditional sales organization, the same result could be achieved by moving away from the dedicated account executive approach, wherein one individual “owns” an account.

Part III: Activity Based Compensation. We refer to traditional compensation as A + B arrangements where A represents the base amount and B represents the at-risk or commissionable component. As indicated above, we have found that traditional base-plus-commission compensation has almost no effect on motivation. The corollary to this statement is that A + B compensation puts the company at risk of distributing the A component for some time without meaningful return on this investment. Stated simply, it is possible to pay out base salaries for six to nine months before realizing that the resource has failed. It is not uncommon for our clients to complain about spending forty thousand to eighty thousand dollars on an individual failure with no measurable results. We find this possibility untenable.

As such, our approach can best be described as A1 + A2 + B compensation, where A1 represents a lower base component and B represents a higher commissionable component. A2 represents what we refer to as “at-risk” base compensation that is equal to or greater than A1. More importantly, A2 is tied to specific and measurable interim events or milestones that correlate positively to the generation of revenue.

Particularly in complex sales environments and long sales cycles, these milestones are the basis for measurable objectives (waypoints) on the path to closing a deal (see Chart 1 below). This approach presents two compelling benefits. The first is that we have found it defines attainable goals that lie within the realm of conscious possibility for most salespeople. In the majority of cases, we have found that the behavioral impact of traditional commission comes too late (at 80 percent probability of close) to affect behavior. Stated differently, traditional commission does little to prevent salespeople from giving up until such point that the deal will progress largely of its own accord.

The second benefit of our approach is that it ensures Three Value Logic Sales Institute is investing incrementally for progress. When appropriately defined, the A2 approach ensures that forward progress is aligned with compensation and, when combined with a distributed resource model, can be pursued with relatively minor disruption when resources fail or leave.

Chart 1

A2 At-Risk Base Compensation Factors

Sample Opportunity Milestones

  • Proposal: The formal delivery of scope and pricing information for client approval
  • Proof of Concept / Demonstration: A specific meeting or initiative intended to validate the ability of product or service to meet a specific client need
  • Discovery Call: Specific scheduled meetings designed to understand client need and/or buying process
  • Advancing Call: Includes all calls resulting in live contact and opportunity advancing conversation
  • Total Calls: Includes all e-mail and telephone communication attempts

Sample Sales Objectives

  • Total annual revenue objective: $1,000,000
  • Average deal value: $250,000
  • Closed business required to fulfill objectives: 4

Sample Milestone Objectives

Based on the above desired outcome, 3VL will define quantifiable milestones objectives for a specific annual period. The following represents an example of how these might be structured. Actual ratios will vary based on sales cycle and product complexity.

  • Proposals: 8
  • Proof of Concepts: 20
  • Discovery Calls: 50
  • Advancing Calls: 200
  • Total Calls: 2500

Milestone Allocation

These objectives can be allocated on a weekly, monthly, or quarterly basis to represent the target associated with the variable base (A2) component. Note that expectations take into account the investment of time necessary to attain higher order milestones. For example:

  • Month one: 250 Total Calls
  • Month two: 250 Total Calls, 20 Advancing Calls
  • Month three: 250 Total Calls, 20 Advancing Calls, 5 Discovery Calls
  • Month four: 250 Total Calls, 20 Advancing Calls, 5 Discovery Calls, 3 Proof of Concepts
  • Month five: 250 Total Calls, 20 Advancing Calls, 5 Discovery Calls, 3 Proof of Concepts, 1 Proposal
  • Allocation of Variable Base (A2) Component

The specific ratio of fixed to variable base can be adjusted according to the relative risk of each resource. For example, with a base salary equivalent to $30,000 ($2,500 per month) the allocation might be based on the following scenarios:

New hire: 50 percent ($1,250) guaranteed and 50 percent ($1,250) tied to the monthly milestone attainment

Six months of demonstrated attainment: 75 percent ($1,875) guaranteed and 25 percent ($625) tied to the monthly milestone attainment

One year of demonstrated attainment: 100 percent ($2,500) guaranteed and 0 percent tied to the monthly milestone attainment

The degree of success with the Resource and Motivation Model also depends on several other factors, including:

  • consistent access to quality resources and effective management of the sales resource lifecycle;
  • the highest level of discipline around activity and opportunity management; and
  • the consistent use of sales force automation technology.

The thought of paying 20 percent of gross revenues to a sales rep is no doubt a very difficult pill to swallow for most CEOs. At best, it seems unconventional; at its worst, utter heresy. But the key is remembering that I'm protecting a massive amount of cash compared to what I'm spending. And I'm more appropriately aligning your investment (the cost of sales) with revenues. This seems far better than investing large sums of money up front in hopes of reaching some magic number.

Some might argue that our people are making too much money. I tell them I’m much happier writing a two-hundred thousand dollar check on a one-million dollar deal than paying half of a ninety-five thousand dollar base salary in the first six months and having nothing to show for it.

© 2006 Townsend Wardlaw. All rights reserved.

comments powered by Disqus

Search the Resource Center

Stay Connected

Email Newsletter Signup

Want to get connected? Sign up to receive regular news, polls and updates from The Kauffman Foundation.

Email Newsletters

Want to be up-to-date with the latest news and updates from Entrepreneurship.org? To subscribe, just give us your email address below; you'll choose which e-newsletters you'd like to receive on the next screen.