Sales Compensation

Salespeople tend to be more motivated by money than other professional groups. That's not terribly surprising, but many founders (particularly those from the technical side) initially struggle with understanding this difference. Sales is a tough job that comes with a high level of frustration and rejection. It tends to attract people who are resilient enough to deal with this adversity, but also expect to be rewarded for their work in fairly direct relation.

Sales compensation systems are based on two main elements:

  1. Fixed compensation, or base salary, is the amount the salesperson receives every month no matter what happens during the term of their employment. The percentage of fixed compensation in sales tends to be quite a bit lower than for most other job functions, often as low as 50% (or or even 0% in special cases).
  2. Variable compensation, often called commission, is the part of the renumeration that varies with the measurable success of salesperson, with their contribution to the company's success. This doesn't necessarily just include direct revenue that the salesperson brings in. Often there are other aspect as well to set the right incentives.

Generally speaking, it is a good idea to compensate all employees who contribute to sales with a variable component that relates to sales success: Customer success, sales operations, sales support, etc. This often means that a company has to develop a fairly elaborate compensation system to make sure that everybody's incentives are aligned and fair.

Variable Compensation Components

The most important variables in a sales compensation plan for an individual member of the sales teams are:

  • Sales quota: This is the amount of sales that the salesperson is supposed to bring in during the relevant timeframe (e.g. per quarter).
  • On-target Earnings (OTE): This is the amount of money, the sum of fixed and variable, that the team member will be able to take home if they achieve their quota.
  • Share of variable compensation: The percentage of variable pay that the sales team member has. This can range from 10-15% in roles that don't move revenue directly (such as CS) to around 25% for roles that have a direct impact on the funnel (e.g. SDRs) to up to 50% for Account Executives. This often scales with seniority, more senior people having a higher percentage.

The share of variable compensation tends to be different depending on the geography and industry sector. Anglo-Saxon countries tend to have a higher variable pay percentage then continental European ones, for instance. It is therefore important to ask around in your industry and geography to find out what typical levels are.

International expansion can mean that you end up having sales groups with different compensation packages. It is possible to find stellar salespeople in Europe who are happy with a relatively low variable component, but this will be different in the United States.

Sales compensation levels

How much of your revenue can go to sales compensation depends on a number of things:

  1. The stage of the company: Younger companies who are still finding their product-market fit will likely have to spend a higher percentage on sales, up to 20-30% of the sales team's revenue contribution
  2. The nature of the business model, particularly gross margin. Obviously, a higher gross margin allows for more leeway in sales compensation.
  3. Customer lifetime value: Bringing in a customer who will contribute revenue for years is of course much more valuable than a one-off transaction.
  4. Geography and industry: Similarly to the variable share of compensation, different markets are comfortable with different levels of sales compensation relative to other cost factors.
  5. The level of impact sales has on revenue generation: Some industries are heavy on marketing or focus on product-led growth. In these cases, sales is often primarily an enabler, which justifies lower levels of sales compensation. On the other hand, complex consultative sales tasks in enterprise software or industrial technology require a higher share allocated to sales costs.

Compensation timing

Most startups have variable compensation for all functions, and typically bonuses are paid once a year. That's OK for most roles, but it doesn't work well for sales jobs. Sales has a much shorter feedback loop, and the power of compensation incentives is significant in motivating a sales team.

The traditional time frame for sales teams is a quarterly goal that is derived from an annual budget goal. Sales team members get quarterly goals they have to execute against, and they get compensated in terms of variable pay every quarter.

Depending on the nature of the business, it can make sense to have more granular targets, e.g. on a monthly basis. This can be energizing for some companies who have short sales cycles, but it can be distracting for others who have to build customer relationships over a longer time. In any case, sales teams should measure their progress on a monthly basis to understand where they stand.

Compensation anchors

The question of what you should anchor your variable compensation to is trivial in some businesses, but quite tricky in others. If the company's revenue consists of one-off product sales, it's very straightforward (think car sales). Salespeople get compensated based on the revenue they bring in, and that's it.

However, if you sell a subscription product, things get more complicated. The initial subscription price a customer might sign up for is only the start of the story. You want to optimize for customers who will expand their plans over time. Also, a customer who stays on for years is obviously more valuable for the business than one who churns after a few months. But is customer loyalty just a function of the salesperson converting the best prospects, or is the role of customer success and product quality the deciding factor?

There is no simple answer to this problem because every business is different (and also might change over time). A good rule of thumb is that salespeople should be compensated for the first year of revenue from a customer, as well as for upsells and follow-on deals that they lead.

Expect some discussion and even conflict around these questions. These are not easy questions to solve.

Setting quotas and other compensation KPIs

How to set quotas properly is one of the most discussed topics in sales. Naively, you could think that the overall revenue budget for the company will be broken down into individual sellers' expected contribution, and that's their quota.

In reality, there are a few things to consider:

  • Higher sales goals tend to have a stronger motivational effect. If you want to reach 100% of your budget (and you will want to do that), it's often a good idea to set quotas to 120% or higher. Some of the team members will achieve this stretch goal, and others will be stuck at 80%. On balance, you will still achieve your overall budget goal.
  • Consider ramp-up times for sellers. People won't be 100% productive from day one, so quotas have to reflect these expectations.
  • Bottom-up calculations: Estimate how much a salesperson can realistically close in new business. This might be a reality check for the overall revenue budget.

Frequently, companies include KPIs other than just revenue into sales compensation. For example, a more profitable customer is of course more valuable to the business, as is one with a longer LTV. Senior salespeople are sometimes expected to lead and mentor junior sellers, so this should be a factor as well. Junior salespeople (such as SDR) sometimes don't have a direct impact on revenue, so they can be compensated on activity levels, such as calls executed.

As a rule of thumb, the more complicated the KPI plan is, the more people will get distracted from their main goals. Adding more than 1-3 additional goals next to revenue impact that are relevant for compensation is rarely effective.

Most importantly, goals should be rooted in reality, and that means historical performance data. Wishful thinking is not a good source for setting sales goals. If you have only a limited track record, you have to work with assumptions, but be ready to admit from time to time that assumptions might have been overly optimistic, and then adapt goals accordingly.

Transparency and internal competition

Humans are motivated by competition, and salespeople are no exception. It is therefore not surprising that many sales leaders implement systems that establish a bit of healthy competition in a sales team. Of course you don't want to drive this to a level of cut-throat competition where people steal leads from each other, but rewarding top sellers not just monetarily but also with recognition from their peers goes a long way.

The pre-condition for this is to establish a certain level of transparency. Sales team members should know on a certain level where they stand against their peers, often down to the specific revenue amounts closed. Of course, specific compensation amounts are typically confidential.

Some companies use leaderboards that are visible to everybody, and while this can seem like a lot of peer pressure, it can be very motivating. Some very experienced salespeople still talk about the glorious day when they took the number one spot on their company's leaderboard for the first time when they were a first-time seller.

Useful Resources

And the iconic video every salesperson knows (or should):