"One of our sales reps is blowing out his sales numbers - and is set to earn commissions that far exceed any other rep and puts his pay higher than mine. Is it ever wise to put a cap on commissions?"
In my opinion it’s a big NO. Capping commissions when salespeople are hot may keep their pay lower than the CEO, but it also encourages superstars to quit selling.
If the commission plan is well designed and a salesperson hits it out of the ballpark, what's the problem? Pay him/her what you promised and hope s/he'll just keep on doing it. If the CEO has a problem then s/he needs to get over it. (I fully understand no one would actually tell him/her this!).
A recent study examined the impact of capping salespeople’s pay. It looked at the compensation plan of a large U.S. contact-lens manufacturer. This company capped commissions at quota. As a result, the salespeople weren’t motivated to exceed them. By eliminating the cap the company increased motivation and revenue increased by 9%.
One way to address a CEO’s concern is by including a “ramp rate”. A ramp rate is used in many different ways, but in this case it can be used to pay commissions at a higher rate once quota is achieved. For example, a salesperson may earn at 1X rate until quota is reached, but earn at 1.5X rate on all sales above that. Quotas can be set as high as possible. By doing so, typically only the superstars will exceed them and get commission at the higher rate. Even though most of the salespeople won’t exceed quota, the fact that a ramp rate exists still makes the plan motivating.
There are other issues with quota-setting. Sometimes companies overpay salespeople with good territories and/or underpay salespeople with poor territories. In other words, quotas are set for every territory as if they all have the same potential.
Example 1: If a salesperson selling office furniture has five big companies move into new facilities in his/her territory, quota may be reached very easily. Success in this case may be more a matter of luck than sale’s talent.
Example 2: On the other hand, if a salesperson has some companies in his/her territory that are in bad shape financially, no amount of sales talent may be enough to enable a salesperson to reach quota.
Setting appropriate quotas requires a fair amount of analysis. It isn’t about automatically ratcheting everyone’s quota up a notch over last year. And it’s not about force-fitting them based on needed revenue. Sales must get a clear understanding of each territory’s potential.
1) Who are the potential customers in each territory?
2) What are their business needs?
3) What is the estimated timeframe that they will be ready to buy?
4) What will it take to close the deal?
- Is it better knowledge of their business?
- Understanding the weakness of competitor products to capitalize on during sales pitches?
- Is technical support needed to provide demos?
5) What will commissions total under various scenarios?
- How many salespeople will reach quota?
- How many will exceed quota and earn commission at the ramp rate?
Companies have gotten better at quota setting over the years partly because better data for measuring territory potential is available. They’ve also improved commission plan design because they can use analytics to estimate the consequences of what will happen if certain variables change.
Quota setting is just one component of plan design. But it can be the biggest motivator/de-motivator. Design without analysis is guesswork. Compensation professionals can and should have input.
Is your company experimenting with its sales plan? A little sulphur here --- a little ammonium nitrate there... Watch out! Your sales plans might just blow up!
What do you think?
Jacque Vilet, President of Vilet International, has over 25 years’ experience in Human Resources. In her current role she works with start-ups and multinationals on both domestic and international HR issues including compensation, learning/development, talent acquisition, workforce planning and mergers and acquisitions. Jacque has an M.S. in Psychology and an MBA from Southern Methodist University. She has been a speaker at conferences in the U.S., Asia and Europe. She is also a regular contributor to various HR and talent management publications and conducts frequent webinars.