Why Sales Compensation Plans Fail… and How to Fix Them

August 30, 2019

Man aiming for a carrot

Sales compensation plans are a great tool for raising motivation and improving selling behavior. However, the results often fall short of management's expectations. We interviewed sales expert Marie Verdier to find out why.

Marie, you are often called in to companies when compensation systems fail to deliver results. What, in your experience, are the key reasons behind this?

Incentive programs are an important element of the sales strategy that should support, and not undermine a company’s main corporate targets. This sounds like pretty standard advice, but we often see that this is not applied to sales teams in the real world. In fact, we recently asked sales executives to name their most potent issues when it comes to sales productivity. Compensation and incentives were by far the most frequent challenge. The reason why? The sales incentive system wasn’t aligned to their overall strategy.

Can you give some examples of what this might look like?

Yes, in fact, I always recommend companies look out for 3 of the most common mistakes:

1. The layer cake: The system includes too many variables and layers, leaving frustrated sales reps scratching their heads trying to figure it out. A recent Simon-Kucher study shows that sales teams perform best with just three variables. Any more than four, their enthusiasm drops, and they give up. Here, less is more.

2. The surprise: The variable remuneration share is paid out annually, giving reps room to maneuver between the individual sales deals and to balance out weaker with stronger performance. Psychologically speaking, frequent payments are more effective in increasing motivation, because reps then see the impact of their performance directly. 

3. The unbalanced agreement: Not all metrics are equal. Yes, one price point has the same effect as one volume point, but not at a margin level. Metric weightings need to reflect your price and volume strategy, and reward reps where they actually have an impact. Let’s take margin – often the one and only KPI used to trigger incentives. If it suddenly improves thanks to a major continuous operations improvement project at the plant, there’s no reason to reward sales. And the reverse is true. Sales shouldn’t be penalized e.g. if procurement costs increase.

compensation example

So some compensation plans could even be called “disincentive systems”?

Yes, some reps actually are punished if they don’t learn to cheat their (flawed) system. Let’s imagine a company lists profit as its number one target. However, the incentive system is exclusively based on generated revenue. The revenue hunters quickly catch on and decide to ignore the target. They grant a lot of high discounts, damaging profit, but they are able to generate higher revenues and are rewarded by the system. Reps that focus on profit (but generate less revenues) are actually punished. They receive low bonus payments, when really the system should be rewarding them for sticking to the predefined price levels and achieving their profit margin targets.

What about the different levels of compensation. Based on your experience, does it make sense to put a “cap” on sales compensation?

There are pros and cons to setting an upper limit. On the one hand, a compensation system that motivates sales to go higher will result in escalating personnel costs. That’s why many companies play it safe and have a cap. But there are also several benefits when you get rid of the maximum limit. Top performers who are demotivated by maximum limits do not reach their full potential. But, once they are on the receiving end of the surplus profits, they start exceeding their targets. There are even scientific studies that prove revenue considerably increases when maximum limits are removed. What’s important here is the economics: Higher compensation must directly translate into higher profitability for the company.

Does this always work?

Actually, it depends, which is why we also recommend incorporating individual steering measures to motivate the different types of reps in your team. For example, weaker sellers increase their performance most dramatically when payments become more frequent, whereas top sellers are most motivated when you take away the maximum limits. Average sellers, who make up the majority of sales teams, react well to multi-level targets and sales competition. Unfortunately, we find that companies simply don’t consider differentiated systems, so they’re not exploiting the full potential of the sales team in this way.

What are the most important success factors when differentiating a compensation system?

First, consistency is still important. Individual targets increase motivation, but reps with similar roles should ultimately get the same opportunities. If an employee with the same performance level earns significantly less than another, this demotivates and creates tension within the team. In addition, you need to be realistic about what is in the sales rep’s sphere of influence, and what is not. If a sales rep is often overruled by a superior when it comes to granting discounts, price implementation shouldn't be a component for this particular sales role. Nothing is more frustrating for an employee than having remuneration targets that cannot be personally influenced.

So what if a company reading this interview realizes that they’re making some of these common mistakes. How can they start making changes for the better?

Even the best remuneration system will be worthless if it isn't practiced. So before you make any adjustments, put supportive change management in place to gain acceptance from the sales team. Integrate opinion leaders such as sales managers early on to function as messengers of the new system and create trust and acceptance. In addition, the new system will only be accepted if it is understood. Here it helps to conduct a before-and-after analysis, simulating the profit effects for employees and highlighting the expected advantages. Rules of thumb such as "if the achieved price increases by x%, the profit margin increases by y%" help sales team members to figure out how they can influence parameters and achieve their goals. Then, once the new system is accepted and understood, the next step is to ensure that it is correctly used in daily business. Plan in plenty of time for any needed IT adjustments and make fair transitional arrangements to ensure that employees accept the new system

Finally, do you have any recommendations on how companies can better keep track of success?

Once a remuneration system is successfully launched or adjusted, the next step is to check if the targets were achieved or if further adjustments should be made. It’s wise to regularly check for optimization potential, even if your system is already functioning well. If a remuneration system doesn't fulfill its targets, it should be adjusted. That’s why a remuneration system needs to be designed with flexibility.
Different functions will require different degrees of detail in their reporting. While a sales manager needs to keep an eye on the performance of all sales reps and is motivated by the overall success, a seller is primarily interested in their own sales performance and compensation. So reporting should also be differentiated, with the relevant information prepared specifically for the recipient.

Ideally, you show the impact of possible sales decisions in real time, with sales reps supported by tools while they are making the deal. However, the costs of frequent and detailed reporting should never exceed the value the reports provide. Intuitive and understandable IT solutions, such as extended personnel and pay calculation systems (e.g. PAISY systems) or pay modules from corporate software (e.g. ERP systems) can help here, allowing sales controlling to create individual reports in real time without high costs.