“How Do I Pay Them?”
Hiring salespeople is hard. In the past few months, I’ve heard this time and again in conversations within my community. Lots of entrepreneurs can describe horror stories of salespeople that didn’t work out: they had expected great things (sometimes double digit revenue growth), but the results were far from expected, leaving the company with a big salary payment to make and none of the revenue growth to justify it.
The single biggest problem I hear entrepreneurs talk about on this topic is about how to design the compensation package. How can the salesperson be incentivized in the right way so they are encouraged to perform at their best, without sacrificing the profitability of the company or creating a drain on cash flows.
In this article, I describe a 6-number formula that can solve this problem. It’s being used to excellent effect by a close friend who has built a sales team bringing in 8-figures of revenue per year.
The easiest way to describe the formula is with this diagram. It’s a combination of 6 numbers broken into two parts: The Base & The Upside.
First – The Base
1) Base Salary
The first part of the formula is to guarantee a base salary that can meet a person’s living needs. Salespeople need to eat and pay their rent just like the rest of us. However, heavily commission-based compensation packages don’t make this possible, and some salespeople feel the anxiety of never knowing how much money they will make that month. If they’re incredibly hungry it might work for them, but for others the anxiety can prompt them into undesirable behavior in an attempt to get a sale at all costs.
As such, the Base Salary is to cover the salespersons basic needs. It’s probably below the market rate for a ‘base salary’ in your industry, but is made up for with other parts of the compensation package. The base salary is a guaranteed payment to cover basic needs.
2) KPI Payment
Let’s assume you know what behaviors a sales person must demonstrate to achieve their results. You might know that it takes 5 meetings to make 1 sale, and 10 calls to get a meeting. So to get 1 sale, the sales person has to make 50 calls. The KPI payment lets you build that behavior directly into a salesperson’s comp package. Every month they have to log a certain type of behavior. It might be calls, or meetings, or proposals submitted. Whatever the behavior, it has a direct and reliable correlation to revenue.
There are in fact two numbers to determine: the KPI metric itself, and then the payment attached to it. The metric might be 50 calls or 10 meetings, or some other measurable behavior that has a direct correlation with closing sales. The payment is a top up to the base salary to take them close to or above market rate.
Importantly – the Salary + KPI Payment can be thought of as the true base salary. If the salesperson is consistently doing the behaviors that are proven to drive revenue growth, they will get the full amount of both those items. In the hiring process, the conversation would go something like this: “Successful salespeople here make at least 50 calls a week (200/month), that turn into 4 closed deals a month. That’s what we need from you for your role to be profitable to the company. It’s an achievable goal and if you’re good there is no reason why you can’t achieve this every month. So part of your compensation package will be a KPI payment that is linked to you making 50 calls per week”.
The secret to designing these numbers correctly is to make sure that the Salary + KPI Payment is at least break even for the company. If the salesperson brings in 4 sales per month, will the additional profit from those 4 sales be at least equal to the Base + KPI of the sales person? If the KPI is also consistently achievable, it will be a sustainable arrangement for both the salesperson and the company.
Lastly, to make managing the sales team’s compensation easier, the onus to demonstrate the KPI has been met is on the salesperson. They have to prove they did the behavior. That means they need to put in place their own tracking system (or use the company’s one) and use it.
The KPI payment is also on a pass/fail basis, so if you’re meant to make 200 calls a month, and you make 191, too bad. A slightly softer approach is to give a one-period 10% grace to accommodate for seasonal fluctuations (eg if the goal is 200 calls in a month, but the person makes 180, they’d still get their KPI bonus that month but have to hit 220 next month).
Second — The Upside
4) Max Bonus (or Commission)
All sales people want to share in the upside of their work. It’s a very powerful and common way to incentive them to put in the effort to go the extra mile and chase the new deals. However, some entrepreneurs pay too much for commissions or bonuses, and sometimes they pay too little.
The objective here is to pick a bonus figure that is deeply motivational to the sales person while still being profitable for the company. If their Base + KPI is $100,000, maybe you want to give them the chance to earn another 50% or $50,000. The Max Bonus figure gives the sales person a number they can aim for and plan their life around.
In some cases, you might not want to set a fixed number here such that there is no maximum. That’s a perfectly reasonable comp package and lots of companies do it. However one counter argument is that infinite upside is essentially the same as a royalty on revenue. It says “I’m going to pay you X% of everything you bring in”. It’s a royalty on revenue which in some ways puts the sales person ahead of the shareholders as the first person to be paid a form of distribution on the success of the company. Something to think about.
5) Sales Target
The Max Bonus should be connected to another KPI, ideally a dollar-figure of new revenue. Using a dollar-figure makes sense here, because it focuses the sales person on the end result. In contrast to the KPI Payment which rewards the right type of behavior, the Sales Target focuses on top line revenue results. In this way, both types of incentives are covered: the sales person is encouraged to “do the right things” and “get the results”.
Setting the Sales Target must take into account the profitability of the company. For example, if you’re selling a product that has a 50% COGS, and the company has 30% operating costs, a new sale brings in 20% net profit. You might want to share a quarter of that net profit with the sales person. This means, for every $100,000 in sales they bring in, they can earn a bonus of $5,000. It makes no sense to give them 20%, because with each new sale the company will at best break even. The exact figure is a matter of judgement for the CEO and management team.
6) Sales Threshold
Finally, the formula requires a 6th number, being the revenue threshold that must be achieved before any of the bonus is paid. For example, if the Max Bonus is $50,000 and the Sales Target is $1m in revenue, you might set a Sales Threshold of 50%, so that the sales person must achieve $500k in sales before they get any of their bonus. Once they achieve that level, they get the first $25k (ie 50% of the Max Bonus) payment and are pro-rated for their sales between $500k and $1m.
The value of the Sales Threshold is that it gives an important stretch target to the sales person. They are incentivized to push towards the Threshold which will unlock their bonus, and then towards the Max so they can make as much money as possible. At the same time, it protects the company against mediocre performance and rewards the better performers.
Choosing The Right Formula
The 6 numbers in the formula are a very flexible system that can accommodate almost every type of sales compensation plan. You could choose a comp package that uses the full formula or zero out a few of the values.
100% Commission = $0 Base Salary, $0 KPI, 0# KPI, Max Bonus = 15% x Infinite Sales Target, $0 Sales Threshold
Base + Bonus = $50,000 Base Salary, $0 KPI, 0# KPI, Max Bonus = 5% x infinite Sales Target, $250,000 Sales Threshold
Base + KPI = $60,000 Base Salary, $40,000 KPI, 200 calls/month KPI, $0 Max Bonus, $0 Sales Target, $0 Sales Threshold
Full Formula = $30,000 Base Salary, $20,000 KPI, 200 calls/month KPI, $50,000 Max Bonus, $1m Sales Target, $500k Sales Threshold
Ultimately the decision on how to structure the compensation might come down to factors such as these:
(a) Company policy based on the culture it wishes to create in the sales team;
(b) Market forces and/or standard practices in certain industry segments; or
(c) Direct negotiation with a prospective employee who might express a preference towards a more stable package with less upside, or a riskier package with higher upside potential.
Recognizing Risk Tolerance
It’s important to recognize the last point. You might have a default starting point, but every individual sales person might need different numbers. It might make sense to adjust the numbers to suit the risk tolerance and ambition levels of the specific sales person. We all have different risk tolerance levels, and while the idea of 100% commission sales packages sounds like a brilliant idea for the company, a person cannot perform if they’re outside their risk tolerance level. It’s a Maslow’s Hierarchy of Needs issue. If a person is overly worried about their living expenses, they may not perform to their best. Anxiety can crush creativity in some circumstances. Exactly where the balance should be is a judgement that should take into account the company’s needs and the personality of the prospective hire.
A shout out to “GQ” for contributing his knowledge to this article. You know who you are buddy. You’re an awesome operator.
Let me know what you think. Leave a comment or connect with me on Twitter.