Sales Commission Structure: Building a Profitable Sales Team

Sales Commission Structure for Incentivizing Growth

Introduction

In the competitive landscape of sales, defining the right sales commission structure for your team is crucial. It sets the stage for attracting top talent, maintaining team morale, and, most importantly, driving revenue. But what does a balanced commission plan look like? In this post, we’ll dive deep into best practices for setting up commissions, with an emphasis on ensuring profitability and competitive advantage.

Understanding OTE: Base and Variable

On-Target Earnings (OTE) is the total potential earnings a sales rep can expect if they meet their sales quota. It’s typically split into a base salary and variable commissions. For example, let’s consider an OTE of $160,000, split 50/50 between base and variable compensation, each being $80,000.

Determining Variable Compensation

Before diving into the complexities of tiered commissions, let’s tackle the budget. Suppose you have a 20-person sales team with a yearly revenue target of $15 million. If we’re aligning with the industry norm for SMBs, around 5% of net revenue, or $750,000, would be set aside for variable compensation for the team.

How Profit Margins Affect Quota

Your profit margins are an important factor in determining individual quotas and overall sales budget. Companies with higher profit margins may afford higher quotas and subsequently higher OTEs.

The Competitive Landscape and Sales Complexity

Higher OTEs might be necessary in competitive landscapes or industries with complex sales cycles, which might require a more skilled and thus, higher-paid salesforce.

Business Stage Matters

Startups might offer a higher variable-to-base ratio to attract talent, while established companies might offer a more balanced split.

Sales Complexity

Longer, more complex sales cycles often require different incentive structures to keep salespeople motivated throughout the lengthy process.

Setting Quota and OTE for Profitability

A good rule of thumb is that the OTE should be less than Quota multiplied by the Cost of Sales. This typically will come out to quotas being 4x-6x of OTE.

Quota Overassignment

Companies often assign more than 100% of the revenue target in quotas when aggregated across the team. This accounts for the fact that not all reps will hit their quota, and some may exceed it. Overassignment rates can vary, but a common range is between 10% to 30% above the revenue target.

Building Your OTE

In a scenario where the quota is $700,000 and the Cost of Sales is 25%, we have the flexibility of offering an OTE up to $175,000. Therefore, our OTE of $160,000 overassigns quota by ~10% and affords us room to include accelerators for high performance into our sales commission structure.

Building Tiered Commissions

Based on the OTE and quota above, tiered commissions can be structured as follows:

TierSales RevenueCommission RatePayout
1st$350,00010%$35,000
2nd$175,00013%$22,750
3rd$175,00015%$26,250
Kicker100% of QuotaBonus$4,000
Adding these up, the total payout would be $84,000. However, if the target variable component is $80,000, you could consider applying a “kicker” or small bonus for reaching 100% of the quota, using the extra $4,000 as that bonus pool.

Why A Tiered Sales Commission Structure Works

Tiered commissions incentivize sales reps to continually strive for higher performance. To learn more about optimizing your sales process, check out How Opportunity Exit Criteria Can Turbocharge Your Sales Process.

Accelerators for Overperformance

For reps who exceed quota, accelerators can kick in, offering a 20% commission rate on revenue above $600,000. This commission rate is still below the CoS of 25%. This effectively keeps reps from sandbagging deals and incentivizes continuous performance.

The Importance of Accountability and Forecasting

In today’s business climate, accountability for sales numbers is moving upward, with CEOs increasingly involved in sales forecasting and deal reviews.

Internal Link: For an in-depth guide on sales forecasting best practices, check out Sales Forecasting Best Practices: A Comprehensive Guide.

Conclusion

Setting up a robust and balanced commission structure is more art than science. It requires a deep understanding of your sales team, market conditions, and most importantly, your financial health. The above guidelines should serve as a strong foundation for constructing a profitable and motivating commission plan.

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