What’s the impact of a $40 million overage on the commission expense budget? If yours is one of the largest technology companies in the world, it means a big “miss” of your earnings forecast and a 22-percent drop in your stock price. This is precisely what happened last year at one company, whose stock is still recovering.
How does a multibillion-dollar company paying more than $150 million in sales commissions a year miss the budget by almost 30 percent? You would hope it means the company exceeded its revenue quotas, but, unfortunately, that wasn’t the case. The reality is that a complex sales coverage model, exacerbated by multiple acquisitions, created an average of more than 50 people being paid for every transaction.
This simple, yet financially painful mistake, could have been prevented if the company had first modeled its commission plans and measured the results against multiple attainment scenarios.
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Doing this would have allowed the company’s executives to evaluate a myriad of changes and options, such as changes to quotas, commission rates, territories and organizational structures, that would have kept it on the straight and narrow.
That company is not alone. Many businesses use the “feels about right” approach to determining payout rates in their sales compensation plans. Once “the committee” zeros in on the basic compensation plan structure, committee members ask someone in accounting to create a spreadsheet to determine the right payout rates.
‘How does a multibillion-dollar company … miss the budget by almost 30 percent?’
While this is done with the best of intentions, the reality is there are neither the tools nor the time to do it right. Best practice dictates that new compensation plans are presented to each salesperson within 30 days of the start of the year, yet, based on Customer Advisory Panel discussions at Centive, we estimate that more than 25 percent of companies do not distribute plans until after the first quarter of the year is over. How’s that for castrating the compensation plan as a motivator!
There are several scenarios that should be considered when modeling the financial impact of new sales compensation plans. The key is to determine how various levels of sales results affect the total commission budget.
Beyond the bell curve
The most common sales compensation plan models include a bell-shaped curve, usually with three different scenarios. The first scenario shows half of the sales reps over quota and half the sales reps under quota; the second shows a curve with the median level of performance being at 110 percent of quota; and the third includes the medial level of performance being at 90 percent of quota.
While the bell-shaped curve technique may be the easiest to model, it also leaves companies most exposed to financial risk. The worst-case scenario for commission expense is that half the sales force blow their quotas away and half don’t even come close.
The result may be that the company hit “the number,” but it also far exceeded its commission budget. Hitting quota and being 20 percent over the commission budget is not a good combination.
To avoid painful financial missteps, it is critical to model compensation plan changes on three different dimensions:
- First, you should model for different levels of revenue results, using the bell curve scenarios.
- Next, you should model using real plan rules. Too often companies use “back-of-the-envelope” math because it is too time consuming and complex to build out detailed plan rules—but the devil is in the details.
- Finally, you need to model your plan against the real sales organization structure. You need to look beyond sales reps to obtain the most accurate calculation. This requires considering the overlay salespeople, sales support personnel, all layers of sales management and others who are tied to sales results.
By considering those three factors, determining the right commission rates and other aspects of the compensation plan can be done with confidence. The range of possibilities becomes known, and the risk financial risk is significantly reduced.
Executives at the technology company with the glaring overage made a simple mistake when they failed to consider the number of people who would be paid under their complex sales model. This is easy to do in a world of macros and linked cells on spreadsheets, but it ended up costing $40 million in expenses and billions in market value.
Sales compensation plans are one of the most powerful tools organizations have to affect sales performance. Properly designed and deployed, sales compensation plans drive superior performance and result in achieving and exceeding sales and revenue targets—without exceeding compensation budgets.