Define your limits in an incentive compensation plan

by on June 17, 2009 · 0 Comment POSTED IN: HR Info Center

Income producer formulas in a incentive compensation plan

“You generate a certain percent of revenue and we’ll give you – or generate revenue and we will give you a certain percent of that revenue”. Small to medium size companies have these kinds of goals for their salespeople in an incentive compensation plan. As you mature though you’re going to have some history about what salespeople can actually generate and whether or not the goals are established correctly for people.

Revenue performance targets in an incentive compensation plan
You will start to move into something called Quotas, which could be based on revenue. But it’s a certain – it’s a revenue target, a quota. But, you get paid based how well you do against the quota.

And, you got a certain percent of your target incentive based on that as opposed to a certain percent of the revenue. You get a certain percent of your target incentive based on how well you do against your quota. And, that’s different from saying you get a certain percent of revenue for all the revenue that you bring in. Generally, these formulas have these kinds of characteristics. Goals are established here. At that level of quota achievement, you want to pay whatever the target incentive is for this particular job. Now, in most cases, how well somebody does against their quota or their target goals will differ. You will have some who will achieve better than target and some will achieve less than target.

Thresholds make people pay their way before the incentive compensation plan kicks in
Let’s talk about less than target first. You’ll see something called a threshold. This essentially says, “That based on their achievement against quota, they have to do a 70% – at least 70% or 71% in order to receive any kind of incentive at all”.

A lot of sales incentive programs don’t even have a threshold. If you’re paying based on a percent of revenue most plans like that literally give them a percent of the revenue from dollar one. Every dollar generates some sort of commission.

A logic for providing some sort of threshold in an incentive compensation plan, is there has to be a point that says, “These people need to at least pay for their base salary, before we’re going to pay them any incentives”. So, I like having threshold. I can tell you, lots of companies don’t and most salespeople don’t like to see that. And, you can see how this work. They got a certain percent of their target based on how well they achieve their – how well they achieve the quota. That’s the target incentive that’s been set up for them.

As, you move up above, meaning that they achieve greater than the quota that has been established for them. You can see that they actually start to accelerate. We, actually, start to give a greater percent of their target incentive based on how well they do against the quota.

Prepare for maximum pay limits in an incentive compensation plan
In some companies, it’s very difficult and you may want to pay even one and a half or even two times the target incentive. That’s possible. In some cases, it’s more variable. It can – the quotas are – you have less reliability on the quotas and, consequently, you may have a higher maximum.

Now, most salespeople do not like maximums in an incentive compensation plan. And, I am for maximums. If, you don’t put it in a formula like this, at least set up maximums to prevent what’s called windfall situations. And, if, you have as a sales program that’s set up to pay a certain percent of revenue for one range or another they fall on to the – they fall into this one situation where they’re literally going to generate millions for the company. And, they’ll get may be hundreds of thousands of dollars in commissions. They didn’t really do anything differently than they would with a normal account. It’s not necessarily based on extra effort. They just have happened to fall into this situation. And, unless you put some sort of maximum on it on at least on account basis, you’ll have to pay that.

Edited Remarks From “Incentive Talk: How to Design an Incentive Plan that Works for – Not Against – Your Company’s Goal” by Rick Olivieri

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