Pulling the right levers – Managing compensation for the sales team

Who remembers those triangles in maths lessons that helped you remember how to calculate one variable given the two others? Essentially you cover up one corner of the triangle then the remaining two variables dictate whether to multiply or divide the remaining two, to give you the missing number. Since I had the memory of a gnat, I used those quite a lot.

It occurred to me that one can apply the model to many scenarios in compensation. Below, is an illustration of how this can be used to think about sales rep compensation.

No alt text provided for this imageTo use an example, lets take a sales person with a target cash compensation (TCC) of $150. Assuming we want them to have a mix of 60:40 (60% fixed, 40% on-target variable), we cover up target incentive, meaning that we need to multiply TCC of $150 by the target incentive portion of 40% which gives us a target incentive of $60.

As a second example, let’s say we know target incentive is $90 and we have a desired pay mix of 55:45. Target incentive of $90 divided by the target incentive portion of 45% gives us a TCC of $200.

Phew. It works. So the point I am trying to get to is not a whole new way of thinking about a relatively straightforward calculation. My point is that contrary to the broader employee population where managing base pay can be done in isolation of short-term incentive, sales compensation needs to be treated differently.

The implication of the triangle is that there is always one variable outside of our control – the “floating” variable. Assuming we want to be competitive in respect of target cash compensation, which is usually the case, we can control either target incentive or mix, but not both. If pay stood static with no increases or variability across roles, this wouldn’t be a problem but because this isn’t the case, we have a decision to make. This leads to two approaches – “Fixed Target” or “Fixed Mix”.

In both cases, the process begins with establishing the desired TCC and mix for a given role. Beyond that, and assuming we want to allow for ranges of pay and merit increases for sales people, there are important differences between the two approaches.

Let’s look at Fixed Target to begin with. In this scenario, with TCC established, we then set a fixed target incentive based on a desired pay mix. Let’s say TCC is $100k with a pay mix of 60:40, resulting in target incentive of $40k. Going forward, target incentive remains fixed meaning that we would usually create a base pay range to accommodate merit increases and enable differentiation within a given role. The practical implication for merit budgets is that we only need to account for increases to base since target incentive does not need to be changed. The side effect is that individuals within a given role will have different pay mixes depending on their base pay.

By contrast, let’s use the same example but take the Fixed Mix approach. We begin with the same numbers – TCC of $100k and a pay mix of 60:40 but from here, the approaches diverge. Preserving the pay mix at 60:40 implies that if we are to provide a merit increase to base, we must apply the same increase to target incentive. This, at first glance, may seem “cleaner” since all individuals on a given role retain the same pay mix however in doing so, the budgeting process should account for the fact that TCC, rather than base, must be adjusted with respect to any merit increase. For companies with a large sales population, this can be a significant cost and must be accounted for accurately in order to understand the associated impact on compensation cost of sales.

The two approaches differ significantly in terms of philosophy. Under the Fixed Mix approach, by assigning both base and target on an individual basis, in a sense the two components belong to the individual. With a Fixed Target approach, the base portion belongs to the individual but the target incentive belongs to the territory as it is driven by the role and not the individual occupying it.

I have a ever-so-slight preference for Fixed Target, both philosophically and to create a more manageable go-forward process however there are of course other factors to consider and, in the end, there is no right or wrong option. The important thing to remember is that it is likely that there will be factors that cannot be controlled for and an early acknowledgment will help the design process go smoothly.

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