The Back Office Reality of Sales Compensation

I have heard from salespeople often that companies are less willing to pay for performance nowadays. This usually led to a discussion on why this might be happening in their company. In the article, I will share some insight on how sales incentive compensation plans are built and what factors affect them from my experience.

Sales Compensation - Field View

Having experienced both the receiving and giving ends of incentive compensation, I’ve seen firsthand how it works from different perspectives. As a sales representative, I was part of an organization that provided a quota, a commission percentage on that quota, and another percentage on all revenue over quota. If you fell below a certain quota attainment, a lower percentage applied. Fall too short, and you zeroed out completely.

There was no need for a compensation calculator to figure out earnings. A couple of quick calculations on the back of a napkin would suffice. Leonardo da Vinci famously said, "simplicity is the ultimate sophistication," and this simple compensation plan certainly fit the bill.

However, as I progressed in my sales career, complexity began to creep in. Plans became tiered, factoring in territory size, the number of reps, reduced accelerators, and higher floors for below-quota performance. The simplicity was lost, and I began to wonder: why the shift in approach? Wouldn’t it be easier to have a plan that everyone could easily understand?

From my peers, I gathered that the increasing complexity was often perceived as a deliberate effort by the company to "make money on the back of the sales team." This led to the rise of compensation calculators, where salespeople would plug in their metrics to see their earnings. There was also a belief that the company had a fixed compensation budget, and this complexity allowed them to control payouts more effectively.

Another common belief was that "the company should be happy if everyone exceeds their quota, as this means more revenue." While there’s some truth to this, it’s a double-edged sword, as we’ll explore.

These perceptions stuck with me until I transitioned into an internal role, where I participated in the incentive compensation process across multiple companies. The experience provided me with a clearer picture of the "why" behind the structure of sales compensation plans.

Sales Compensation - Back Office View

When I moved to an internal role, I finally saw how compensation plans were created. Just as the sales team had quotas to hit, the Finance team had a budget to meet. The Finance team would take sales projections from sales and marketing, compare them to historical data, and verify with Operations whether we could produce the necessary amount to hit those numbers.

It's important to note that Sales Compensation/Incentive Compensation may live outside of Finance in your organization—perhaps within Commercial Excellence, Commercial Operations, or Sales Operations. For this example, however, we’ll assume Finance owns the budget.

Budgeting and Forecasting: This is where the budget plays a crucial role. Internal teams must assess how much it will cost to make and sell products versus how much we can realistically sell. If we expect to sell a certain volume, production costs—including materials, salaries, and headcount—must align with the expected revenue.

As salaries (often with a 2-5% annual increase) and production costs (particularly due to inflation) rise each year, companies must either raise prices or increase sales volume to cover these additional costs. However, raising prices and increasing volume do not have the same impact on profitability. Organizations generally prefer an increase in ASP (Average Sales Price) because it contributes directly to the bottom line—every dollar increase in price is pure profit. In contrast, increased sales volume is influenced by the product's margin profile (e.g., a $1 price increase adds $1 to profit, while a 53% margin on a product sold at the same price only adds 53 cents to profit).

Understanding ASP: The ASP is crucial here. If ASP doesn’t outpace rising costs, this reduces the budget available for other critical areas, including sales compensation. As most of us work for growth-focused organizations, we need to grow the business over the prior year, which often means asking the sales team to do more with the same resources from the previous year if price remains static or if sales volume does not increase. This can also lead to internal teams being required to do more with the same or fewer resources, potentially resulting in projects being shelved or headcount reductions in non-revenue-producing roles.

Quotas and Compensation Adjustments: If sales headcount needs to be added to cover demand, the expense must be covered within the organization to stay ahead of last year's profitability numbers. If sales compensation needs to be adjusted or increased over last year, the cost must be accounted for. One way to manage this is by requiring the sales team to take on additional quotas. However, if projections are based on historical numbers, this creates stress on the system as quotas are increased beyond what the field believes it can achieve.

Impact of Exceeding Quotas: What if the sales team crushes their quota—does that solve the budget problem? Not exactly. Typical sales compensation plans target a payout of 65-80% of on-target earnings. If quotas are blown out, the budget is weighted more heavily toward more expensive compensation in the form of over-plan earnings. Additionally, the 20%+ of reps who unexpectedly hit quota also impact the total budget for compensation.

It also places strain on the system, as the business was not prepared to build this many widgets and now has to scramble to increase capacity. This could mean sourcing more product from suppliers (who built their budgets based on the original projection), hiring more staff to build more products (often with overtime, increasing costs and affecting margins), and increasing logistical support (delivery, warehouse, management).

Circling Back to Sales Compensation

When you see additional complexity in your sales compensation plan, chances are this is not an attempt to limit the sales team's earnings directly. Instead, it’s a way to ensure that the compensation budget is met based on last year's performance metrics. If the budget is exceeded, the impact on profitability can have negative consequences on current and future resource allocation, as this is a zero-sum situation where the books must balance.

Still, as a salesperson, it may be difficult to compare compensation from years past to today. Many will see that they are selling more today than before (they are better sellers, their markets are more developed), but their compensation remains relatively similar if they are in the same organization. With increasing people, infrastructure and production costs, unless ASP or volume increases, this trend will likely continue.

As a salesperson, you have a few options.

Large vs. Small Organizations:

• Large Organization: Consider what you’re gaining in trade if you see your commission is static or declining. Resources, support systems, career progression, brand reputation, relative stability, and internal networking opportunities are all potential benefits of working in a large organization.
• Small Organization: If you’re part of a smaller organization, you may see higher commission percentages as the organization seeks to carve out its place in the market. Potential benefits of a smaller organization include higher earning potential, commercial agility, expanded influence, and greater opportunities for advancement.

Deciding whether to stay with your current organization or move to another one ultimately depends on your goals and how you believe you can achieve them in your current situation.

According to recent data from Salesforce, 64% of sales professionals said they would be willing to leave their current organization if offered additional compensation for a similar position. However, compensation historically is not the primary reason a person leaves a company.

Multiple studies show that career development opportunities are the primary reason employees leave, followed by compensation and benefits. These data suggest that if leaders prepare and communicate clear career development paths and provide development opportunities (e.g. emerging leader programs, developmental assignments, mentorships) combined with competitive compensation, they are much more likely to retain their high-potential talent.

Final Thoughts: Understanding the complexities of sales compensation and budget constraints can provide clarity on why certain decisions are made. The goal may not be to limit the salesperson's earnings through complexity but rather to ensure the company does not exceed the compensation budget, ensuring the company's financial health and long-term sustainability.

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