When Wells Fargo designed its incentive compensation program, leaders most certainly did not expect its impact: $185 million in fines; the firing of 5,300 employees; the clawback of $75 million in compensation from top former executives; the ouster of the CEO; and a global scandal in which as many as two million customer accounts were opened illegally.
Sales incentives are powerful. You get what you pay for. In the case of Wells Fargo, what the bank paid for was disastrous. But if conceived and structured properly, incentives should drive behaviors that result in higher profits, the retention of top performers, and a culture of excellence.
Incentive compensation is often one of the biggest items in a company’s budget. It’s expensive, and trimming the cost can be a tempting opportunity for a CFO. But instead of agonizing about the amount, finance chiefs should consider sales compensation as part of the company’s investment portfolio and demand an attractive return.
CFOs tend to think about the total dollars they’re spending on sales compensation. Instead, understand what you’re willing to pay for each level of performance and type of revenue.
Performance Levels and Revenue Types
Target performers are the salespeople who just meet their quotas and earn their target incentives. Their neighbors, the “mighty middle,” range 10% to 20% above and below quota and make up the bulk of the organization. It’s important to get the incentive and return right for this group, because they represent 60% to 80% of the organization and the bulk of the cost.
But the investment levels that drive CFOs crazy are pay levels for the very high and very low performers.
Top performers — those in the 90th percentile of your sales organization, sometimes called the “excellence level” — can earn 200% to 300% of their target incentive. Depending on the organization, related performance may range from 120% to 150% of quota.
The upside can get expensive, and CFOs tend to question why it’s necessary, especially if the compensation plan doesn’t have a cap. But the idea here, again, is that there’s a worthwhile return. In a properly designed incentive plan, you’re not paying hundreds of thousands — or in some cases millions — of dollars unless the company is benefiting.
Without upside potential, the incentive compensation plan favors the company but leaves it with only average sales talent. A core principle of incentive compensation is that the rep is putting incentive pay at risk in return for a significant return if she performs at a high level.
Bottom performers — typically the lowest 10% of achievers — should be paid a fraction of what a target performer earns. It’s important to clearly understand what you’re paying this group; in too many organizations we see bottom performers earning a pretty good living, sometimes close to their target incentive despite being far from quota attainment.
Thresholds are used to prevent the overpayment of lower performers. They can also fund upside incentives. We call it the reverse Robin Hood principle, because the company takes the incentives that would be paid if a threshold didn’t exist and transfers them to the top performers.
In addition to understanding what you’re paying for performance, consider what you’re paying for each type of sale:
- Retained revenue. On average, companies retain 80% of revenue year to year. Current customer retention will offer the highest ROI, because you’ll have a huge installed base relative to the amount of sales compensation it takes to manage that base.
- Penetrated revenue. Penetrating current customers typically represents 15% to 20% of revenue. Your current customer penetration will be your average ROI for incentive compensation.
- New customers acquisition revenue. Companies earn about 5% to 10% of annual revenue through new customers. But that revenue can cost two to four times what current-customer revenue costs. If your strategy has a heavy focus on new customer growth, you’ll have to pay those higher rates for the short term, and then over the next year or two convert that new customer revenue to account management, which carries a lower cost of sales.
If caught in a dilemma where you’re paying new customer-acquisition rates for business the company has had for years, you should restructure your incentive compensation plan and lower your cost of sales. Compare sales costs according to revenue type. You may have created an annuity plan that continues to pay the hunters for years for business they’ve already acquired.
Understand the ratios for what you’re willing to pay a high performer versus what you’re willing to pay a low performer. Consider each level part of the overall investment strategy, and determine specific returns for each.
Measuring the Return
ROI has many definitions. The most common for incentive compensation is productivity value divided by the financial costs invested in the compensation plans. The most obvious type of return is increased revenue.
But returns can be both financial and strategic. Additional financial returns can be increased profitability, increased bookings, and decreased expenses. On the strategic side, returns can include an improvement in performance for certain products, growth of certain markets, and decreased sales-force turnover.
Your company strategy will determine how your ROI definition is developed. For example, your company may be interested in growing revenue in a certain area of the business or focusing on a new product set. Metrics associated with the return on those facets of the business will drive how you develop what’s important in your ROI definition.
Or, your strategy may dictate that you need to invest more in an emerging market or technology that is different from your traditional business. In that case, you could calculate a separate ROI on those business lines or products in order to understand that specific return.
Strategies involving new customers and new products will tend to be more expensive than an existing customer or product strategy. This may be because the sales cycle is longer, the close rates are lower, the sale is more difficult, or perhaps it’s a strategic product that isn’t yet producing the returns that it’s expected to in coming years.
Setting a company’s strategy is a collaborative exercise that evaluates customer, product, coverage, financial, and talent goals. It is clearly communicated throughout the sales and sales-support organization.
Money talks, and incentives typically trump leadership messages, sales strategies, sales management, and sales training. Use this powerful tool to drive the correct — and legal — behaviors and to celebrate the returns on your investment.
Mark Donnolo is managing partner of SalesGlobe and the author of three books: “What Your CEO Needs to Know About Sales Compensation,” “The Innovative Sale,” and Essential Account Planning.”