- Blog post
Sales compensation: What’s the best way to structure bonuses?
When it comes to designing sales compensation plans, sales directors often have little to go on other than instinct and experience. Everybody agrees that salespeople need to have some skin in the game, and bonuses are one way to make that happen.
But what’s the most effective way to structure them? If you set the bar too high, will it demotivate salespeople who are struggling to make quota? What should you do about high performers after they hit quota? Is a big end-of-year bonus more motivating than smaller quarterly bonuses? Or should you keep things simple — forget about complicated bonus plans altogether and just pay commission?
Research to the rescue
A working paper from Harvard Business School offers some practical insights on how to maximize the effectiveness of bonus plans for sales forces. A few highlights from the study:
1: Bonuses do work
Yeah, seems obvious. But many “obvious” truths in business turn out not be true after all. And since U.S. businesses spend more than $800 billion a year on sales compensation, it’s worth asking the question: Do bonuses actually improve sales productivity?
They do. But it doesn’t mean all that money is well spent. Read on.
2: Commissions and bonuses work differently
Some companies — about 25% of them — take the position that commissions alone are the most effective way to boost sales: Sell more stuff, make more money. Sell less stuff, go home hungry. Why complicate things?
Here’s why: Bonuses do more than put extra money in the salesperson’s pocket. They create performance standards. Bonuses are tied to quotas, and quotas drive behavior. People are more purposeful and focused when they have a target to aim for.
To see the difference, consider this scenario: A salesperson earns 20% commission and has a $10,000 sale in the pipeline. Without a bonus, that deal is worth $2,000 to him or her, no matter when it closes. But if that sale gets the salesperson to quota for the quarter, it’s worth the commission plus the bonus. So the salesperson has a bigger incentive to close quickly — which helps him or her stay on track for the year.
3: Small, frequent bonuses work best
The study found that quarterly bonuses are more effective than an annual bonus. The reason is a psychological phenomenon known as temporal discounting. Temporal discounting means that we discount the value of future events. And the farther in the future they occur, the greater the discounting. So a small bonus in the near future has as much or more motivational power than a much larger bonus in the distant future. (Presumably, monthly bonuses would be even more effective, but the study didn’t look at them.)
In addition, the researchers noted that people are less likely to throw in the towel with more-frequent bonuses. A salesperson who’s off pace for the first three months of the year, for example, may conclude that he or she will never catch up enough to earn an annual bonus. But if the scorecard resets every quarter, they’re motivated to hang in and push harder next quarter. According to the researchers, short-term bonuses “serve as a continuous evaluation scheme to keep sales agents within striking targets of their annual quotas.”
4. Pay higher commissions for performance beyond the quota
How do you keep productivity from slacking off after a salesperson reaches quota? The researchers found “clear evidence that … overachievement commissions help sustain the high productivity of the best performers even after attaining quotas.”
In other words, the bonus is only part of the reward for making quota. The other part is that salespeople get to keep more of any additional deals they bring in. So that $10,000 sale is now worth $2,500 or $3,000 instead of $2,000.
That’s a deal companies can easily afford, because post-quota sales are so profitable. The fixed costs associated with the salesperson– office space, overhead, base salary, benefits and so on — have already been amortized. With minor exceptions, the only incremental cost of the sale is the commission itself. The rest is pure gravy.
Source: Chung, D. J., Steenburgh, T., & Sudhir, K. (2013). Do bonuses enhance sales productivity? A dynamic structural analysis of bonus-based compensation plans. Marketing Science, 33(2), 165-187.