How to Develop a Sales Compensation Plan

Your company’s salespeople are one of its most important resources – without any sales professionals, your sales department can’t make any sales, meaning no cash flow or revenue. Your business would quickly grind to a halt.

The quickest way to lose a sales representative is to underpay them. That’s why it’s important to develop an enticing sales compensation plan that pays your sales reps fairly, encouraging them to stay with your company and work their hardest. And beyond simply rewarding your sales reps, a smart sales leader can also use their sales compensation plan to guide their sales department toward company goals. 

If you haven’t given much thought to how you compensate your reps, this guide will give you all the pointers you need to create a compelling and strategic sales compensation plan, setting up your sales department for long-term success.

What is Sales Compensation?

Let’s start off with our basic definitions.

But unlike most other jobs, sales positions are often paid with a commission component, meaning they earn extra money per sale made. This is because the rep’s individual persuasiveness, pleasantness, and sales skills are usually deciding factors in whether each potential customer decides to purchase or not. As opposed to simple salaried reps, commission structures encourage sales reps to grow better, make more sales, and allow high-performing sales reps to be aptly rewarded for their efforts.

The exact formula for an employee’s sales compensation varies quite a bit: after all, you wouldn’t pay a highly-experienced real estate agent closing million-dollar homes with the same rates as a rookie online telemarketer, would you? 

To that end, different companies and sales teams all have different sales compensation plans—formulas for calculating sales compensation—catered to their industry and product, along with employee-specific considerations such as the salesperson’s role, tasks, and seniority. 

Why Are Sales Compensation Plans Important?

To a sales manager trying to balance their budget, it might seem quite a lot easier to simply set a salary for an employee and let them make sales at their own pace, or be more frugal and only pay employees per sale made. But putting a little more consideration into your sales reps’ payment plans can provide quite a few benefits for employers and employees alike. Below, we take a look at four concrete benefits.

1. Decreasing the turnover rate

Though the national average turnover rate is 18%, this number almost doubles to 35% for salespeople. Evidently, salespeople who aren’t happy with their jobs are eager to leave. Offboarding an employee and training a replacement can be costly, so companies would be wiser to instead offer competitive and satisfying compensation plans that encourage sales reps to stay with the company. 

The longer a sales professional stays with your company, the more sales talent they’ll accrue. Thus, by decreasing the turnover rate, your sales team’s skills will only improve over time.

2. Motivating employees

If a manager pays their salespeople a no-frills steady salary, they run the risk of slackers in the sales team who soak up the budget without contributing a single sale’s worth of revenue. That’s why sales managers often implement commission-based compensation, meaning that reps are only paid if they close a sale. This ties an employee’s remuneration to their performance, encouraging them to work harder and take home more money.

Plus, if you create different compensation plans for different job titles, this creates opportunities for reps to be promoted to a more well-paying position or choose the compensation plan best suited to their abilities. A little extra incentive to do their best!

3. Close more sales

Similar to the last point, a well-designed commission-based compensation plan encourages employees to work harder and close more sales, which boosts your sales department’s performance and the company’s revenue.

Even with salary-based compensation plans, sales reps still usually have to meet certain activity targets and performance goals, creating a steady baseline for sales forecasts. But by adding a variable component to their compensation, a business can hope for their salespeople to go above and beyond, closing as many deals as possible.

4. Align sales with the company’s goals

Finally, a sales manager can adjust compensation plans to ensure the department’s budget matches the company’s overall financial situation and sales strategy. For example, a sales manager could choose to implement a more salary-focused approach to make payroll accounting more predictable, or choose a commission-based structure if the company hopes to exceed its sales quota and make as many sales as possible. 

7 Common Sales Compensation Plans

Of course, there’s no need to reinvent the wheel: sales is one of the oldest professions, and plenty of companies have created catalogs of compensation plan structures that have worked for them. Here are seven of the most common sales compensation plans that you could use to create your own.

1. Salary-Only Compensation

The simplest compensation plan is a salary-only structure, where a salesperson gets paid the same regardless of how well they perform beyond meeting their quota.

• Pros: Because wages are consistent, it’s easy for managers, HR, and the financial team to calculate sales expenses and run payroll. With a clear minimum number of sales per rep, predicting the department’s hiring needs for scaling up also becomes much easier to determine. Employees are also generally happier and less stressed because they know they’ll make money at the end of the day.
• Cons: Without any effort-based incentives, sales reps might not make any more sales than they’re required to. Additionally, if there’s no set quota, there’s also the risk of underperforming sales reps being paid the same as everyone else.

Though salary-only compensation may be the easiest to manage for everyone involved, we wouldn’t recommend using it for small and growing businesses. The lack of motivation for hard work means that the company is unlikely to see any additional sales beyond reps’ designated quotas, meaning that the company won’t see any growth.

2. Commission-Only Compensation

On the other extreme, commission-only compensation pays employees solely based on their performance: if they make more sales they get paid more, and if they make no sales they don’t get paid at all. Employees paid by commission rate make anywhere from 5% to 45% of the revenue they bring in, depending on the product and how much elbow grease reps put in per sale.

• Pros: The company sees no risk, as it incurs expenses only for closed sales that bring in revenue. Employees will also work harder to be paid more.
• Cons: Employees may feel constantly stressed to constantly make sales, leading to burnout. Companies may also find themselves paying unpredictably large sales expenses if reps sell more than expected. If the market experiences seasonal swings, sales reps may not get paid at all.

This compensation plan is the extreme opposite of the salary-only plan. We wouldn’t recommend this compensation plan either for small and growing businesses, as it can make expense accounting and inventory management unpredictable month-to-month. Plus, there’s a higher-than-usual chance of your sales reps burning out, leading to additional expenses to hire and train new employees.

3. Absolute Commission

Unlike the previous commission-only compensation plan calculated by a percentage of the sale, absolute commission rewards reps with a lump sum simply for hitting designated goals that might not be a strict sale: for example, the number of leads they bring in, making a certain number of calls, or acquiring new customers. 

For example, if your company tried to implement a cold-calling campaign, you could pay a rep $100 per 10 outbound sales calls they make regardless of whether the call blossomed into a sale or not. This would encourage reps to make more phone calls.

• Pros: Easy for reps to understand, clear motivation for reps to work harder. It could help reps develop skills in areas where they’re underperforming.
• Cons: Reps may tend toward only performing the task that earns them the bonus payment rather than the ultimate goal of making a sale.

An absolute commission structure motivates reps to work harder and boosts sales performance, but a sales manager must be careful to align the commission target with the company’s overall strategic goal. 

4. Base Salary Plus Commission

A happy marriage of the salary-only and commission-only structures, the base salary plus commission plan pays reps a fixed base salary plus a variable bonus commission payment. 

• Pros: Employees feel security with the base income while also being incentivized to work harder. Forecasting expenses becomes easier with more consistent salaries. Salaried employees are also obligated to perform non-sales tasks such as training new employees, thereby boosting the department’s overall performance.
• Cons: This plan risks the same cons of the salary-only and commission-only plans, albeit to a lesser degree: employees might not be incentivized to sell more, or employees might feel stressed to sell as much as humanly possible.

Approximately half of all sales organizations use a base salary plus commission model, so we’d recommend using this if you’re not sure what else to do. The standard ratio of salary-to-commission is 60-40, but this could skew depending on how difficult your sales are, how much autonomy reps have in a sale, how many leads the rep manages, and other factors. 

The more impact a rep’s performance has on a sale, the more the ratio should be skewed in favor of the variable commission-based compensation. On the other hand, if a rep has to spend more time teaching leads about complex products, they should be rewarded for their technical expertise with a more stable base salary so they can focus on building the customer’s knowledge base.

5. Base Salary Plus Bonus

If your sales reps tend to consistently meet your goals and quotas, a base salary plus bonus plan removes some of the variability from the previous base salary plus commission plan while also motivating reps to close sales. In this structure, rather than paying sales reps a variable amount from commissions, reps are given a lump sum bonus for meeting a designated goal beyond their quota in addition to their base salary.

• Pros: Simpler to budget because there’s only two possible amounts that a sales rep can make: only their base salary, or their base salary plus the lump sum bonus. Sales reps will be motivated to make enough sales to hit the designated sales target, but rest assured that they’ll receive a salary regardless of if they achieve the goal or not.
• Cons: Reps aren’t incentivized to make any more sales beyond what’s required to receive the bonus.

For example, a sales rep could receive a $35,000 base salary plus an additional $20,000 if they make 20 sales in the month. If you have nine experienced sales reps who meet this target and one new rep who isn’t quite there yet, you would know to set aside $530,000 to pay your employees. The new rep would also be motivated to close that gap as soon as possible. 

6. Gross Margin Commission

Rather than basing variable commissions on the sticker price of the item sold, you could instead use gross margin compensation, where reps are paid according to the gross profit margin the company earned on their sale. 

For example, if a sales rep sold a product for $100 to one customer but had to discount it to $75 to sell to another, they would earn less on the discounted sale. 

• Pros: Encourages reps to sell higher-priced products and discourages discounting to close more sales.
• Cons: Calculating each sale’s gross margin could be difficult due to changes in manufacturing and shipping fees, rebates, and territory changes.

Because this compensation plan depends so strongly on having variable revenue per sale, it should only be used by companies where sales reps are given great authority over the price point of each individual sale (such as a car dealership) to discourage them from handing out too many discounts. If you sell goods or services at a fixed price, then another compensation plan would be much easier.

7. Territory Volume Commission Plan

If your business covers a lot of square mileage or operates internationally, you might’ve carved up the map and assigned sales teams to each region. A territory volume commission plan takes the total sale amount made per region and splits it evenly among the reps in that team, encouraging them to cooperate and make more sales.

• Pros: Encourages teamwork in each territory’s sales team and competitiveness between territories.
• Cons: Risks freeloaders in teams. Relies heavily on the notion that each territory has equal numbers of quality prospects, as teams with no prospects can’t make any sales.

Though seemingly a no-brainer choice for companies with regionally-based teams, tying compensation to each team’s territory means that reps in territories with more prospects will inevitably make more than reps in barren territories. Because of that, we’d recommend regularly rotating reps between territories for fairness’s sake, or switching to another compensation plan that gives reps a chance to succeed based on individual merit rather than the territory’s.

Steps to Develop a Sales Compensation Plan

Now that we’ve explored all of these different compensation plans, how do you determine which one is best for your company and department? Or is it time to create your own unique compensation plan? To answer those questions, here’s an easy step-by-step guide to finding the right sales compensation plan for you.

1. Consider your business and goals

As we briefly mentioned before, your company’s industry and products will determine how active your sales reps are at different time periods and how complex each sales conversation is. For example, if you sell something seasonal, like travel bookings, it would be best to have a more salary-focused compensation to avoid wild fluctuations between your high and low seasons. If you sell a product that requires more complex or technical explanations from sales reps, their salary should likewise be higher to compensate them for their expertise.

Next, think about your company’s long-term plans. If your company plans to expand operations and wants to sell as much as possible, a highly-variable compensation plan, such as a commission-only plan, will encourage reps to make as many sales as they can while reducing costs. Alternatively, you could choose a salaried plan to maintain the status quo and employee morale if business is already good enough.

For budgetary restraints, when creating a baseline dollar amount for your salaries, additionally consider the living costs in your area and what competitors are paying. If you’re thinking of hiring more sales reps, consider the overhead cost of acquiring and training new reps versus simply using a new compensation structure to push the reps you already have. 

2. Determine your KPIs

Next, determine the KPIs your sales reps’ compensation plans will be based on. Though most of these plans focused on the revenue or gross margin the rep’s deals brought in, absolute commission plans can reward reps for other activities such as identifying new leads, making phone calls, or bringing in new customers. 

Likewise, while your sales department generally wants to make more money, it might have goals such as attempting a new outreach campaign, breaking into new territory, sniping customers from competitors, or building a stronger customer base. Your compensation plans should reward sales reps for tasks that support your business’s overall strategy.

3. Define your unique sales roles

Within your sales team, how many unique roles and job titles do you have? It would be best to have a different compensation ratio or pay range for each sales role. Not every employee can be paid the same – you can’t use a commission structure for a sales manager, for example, because they don’t usually make sales themselves. Reps with more experience, technical ability, or managerial functions should generally be paid more with a higher salary-based portion of their compensation. 

While you may not need to implement an entirely different compensation plan for each position, you should at the very least change each role’s salary-to-variable payment ratio or success KPIs. Additionally, having a clear hierarchy in your sales department gives entry-level sales reps chances for upward mobility, encouraging them to work harder in hopes of being promoted.

4. Determine your structure

Considering the list provided above and factors we described in the previous steps, choose a compensation plan suited to your business and departmental needs. For your chosen plan and each unique role within that plan, determine your:

• Target Pay: The total pay and compensation package offered to employees. The sum of an employee’s salary, commission, bonuses, perks, and other benefits.
• Pay Mix: The ratio of base salary to flexible sales incentives, which should total to the target pay. For example, a 60-40 split between salary and commission pay.
• Upside Potential: The variable potential pay you could give reps who exceed quotas.

Your pay mix and upside potential should be more aggressive for sales reps that have a strong influence on a customer’s purchasing decision, which depends on your company’s product and sales process. In other words, the more persuasive sales reps must be in a sale, the more you should incentivize them to win over customers. 

On the other hand, support your supporting roles and more technically-advanced salespeople, such as CRM managers, with a less aggressive pay mix that favors a consistent salary. This encourages them to focus on maintaining the department’s infrastructure, do less glamorous tasks, and, if your product requires a longer sales cycle, take extra time to ensure their tasks and sales are done right. 

In your overall budget, it would also be wise to allocate some extra money for sales performance incentive funds (SPIFs). These are small, short-term sales bonuses used to incentivize the team beyond their standard pay, such as bonuses for monthly competitions between sales teams, prizes for the employee of the month, or teambuilding activities. Even a little money in these events could significantly boost employee morale.

5. Communicate your strategy

Finally, once you’ve got all the details worked out, the last step is to sit down with your sales force and discuss your sales compensation plan going forward. Tell them why you chose your plan and the goals you’re trying to achieve with it. This will give reps a clearer idea of what they’re supposed to be working towards strategically.

Let your sales reps voice objections and suggestions, and make any final tweaks to your compensation structures. Once you’ve got your sales team’s approval, you can finally implement your new sales compensation plan.

Conclusion

With a well-designed sales compensation plan, sales managers can decrease turnover, boost employee morale, increase sales, and further the company’s goals – all without lifting a finger. That’s why it’s important for sales managers to develop an effective sales compensation plan and pay mixes perfectly tailored to their department’s unique wants and needs.

Though there are dozens of different sales compensation plans you could choose from, this guide hopefully put you on the right track to identifying the best one for you and customizing it for your sales team. With some careful thought and hard work, a business owner or sales manager can implement an attractive sales compensation plan that’ll keep sales professionals happy, motivated, and closing more sales than ever before.