Every business person knows the Principal-Agent Problem, even if they don’t habitually call it that: someone wants something, but they can’t get it on their own, so they pay someone else to get it for them. Where’s the problem? The difficulty arises when the person hired doesn’t want the same thing as the person who hired them, so they don’t try very hard. Instead, they exert the minimum possible energy to get paid.
That’s putting it very simply, but sales operations leader will recognize the dilemma instantly. The company (the Principal) wants profits, but the sales rep (the Agent) wants an income, and those aren’t the same thing. Their interests don’t align. The solution is straightforward: match the interests of the two parties by allowing the rep to access the profits of the company, by taking a percentage of the revenue on the products they sell.
That’s also putting it very simply. As sales operations leaders also know, creating the right sales commission strategy can be a complex endeavour. There are many variables to consider, such as the customers in your market, the scope of the territories you’re accessing, the products you’re selling, the sales cycle for those products, the specific demands of your industry, and the skill and experience of the sales reps, among others.
But a smart sales compensation strategy not only overcomes the Principal-Agent Problem—it inspires sales reps to adopt and express desired business objectives in all their customer interactions.
Once you’ve done a detailed cost-of-sale analysis and established the compensation mix of base salary and commissions, you’re ready to create an incentive plan that sparks the kind of behaviour you’re looking for. Here are four types of commission strategies to consider when developing your plan:
- Flat – This is the most obvious and the easiest plan to implement. Whichever product the rep sells, the commission stays the same. Flat commissions (sometimes called “fixed”) can be calculated by the dollar or by the widget. This type of incentive is often used in insurance and real estate markets, and can be reassuring for customers, who know they won’t be needlessly oversold. That, in turn, makes the rep’s job easier, and can drive sales.
- Tiered – This plan gives top sellers extra incentives and rewards them for their quality work by increasing their commission once they pass pre-established sales targets. It also has the secondary benefit of motivating reps who produce fewer sales and see their colleagues earning more. Whereas the flat commission is broadly categorized as a “commission-based plan,” tiered commissions are treated as “achievement-based plans.” Tiered commissions increase marginally (applying to all revenue earned in the upper tier) or retroactively (including revenue earned previous to meeting sales target). Without tiered compensation, reps might be tempted to “sandbag” their sales, or save them to ensure they meet quota in the future. But the success of the tiered plan depends on realistic and obtainable sales goals, for which you’ll need accurate, up-to-date information along a variety of metrics.
- Hybrid — As the name suggests, the hybrid plan combines flat and tiered commissions. In this system, commonly used in the pharmaceutical industry, a rep is initially paid a percentage of their target achievement, until they reach their goal. After that, they earn a flat commission on anything sold above their quota.
- Multipliers — Multiplier plans are more complex, and so they allow companies to create more nuanced compensation strategies. They’re useful when you want to apply multiple components—or performance measures—to an incentive plan. For example, you might start with a flat commission, but multiply it by a percentage factor of quota achievement. To fine-tune how you motivate your reps, use multipliers that reflect the sales cycle and other factors specific to your industry.
In cases where sales reps sell a wide variety of products with different pricing, it can be better to use a variety of commission types. Alternately, a company may want to incentivize its reps to sell specific products—like the ones with the highest gross profit margins—and so it sets custom parameters for the commission on that product, thereby stimulating reps to exhibit the desired behaviour and to sell at a higher volume in the targeted area.
Companies need the flexibility to adjust their priorities to market demands, and then to motivate reps to share the same goals. Appropriate incentive plans help the company and variable-pay employees align their behaviour and expectations.
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