What is incentive compensation?
Incentive compensation is a form of variable compensation in which a salesperson’s or other employee’s earnings are directly tied to the amount of product they sell, the success of their team, or the success of the organization as a whole. Incentive compensation management is the strategic use of incentives to drive better business outcomes and more closely align sales rep behavior with the goals of the organization.
Incentives in an incentive compensation plan can take many forms, and may include commissions, bonuses, prizes, SPIFs, and recognition. Incentive compensation plans are ideally designed so that salespeople can maximize their rewards as the company maximizes revenue.
Ideally, a company’s sales incentive compensation plans should be arranged so that the company’s salespeople can earn the most money when they help achieve the company’s most important sales goals. Getting to this point can be difficult. To help, we’ve put together a complete introduction to incentive compensation.
Who owns incentive compensation management?
According to research from the Sales Management Association (SMA), sales leadership and sales operations are the divisions that most likely create and manage an organization’s compensation plans. Other functions such as finance, human resources, marketing, and IT may also be potentially involved in managing sales compensation plans.
These various functions may play different roles in creating and managing a company’s sales incentive compensation plan. Ownership of compensation plan design and management can also vary by industry or company strategy.
According to SMA, in nearly 50 percent of organizations, sales operations is responsible for designing the incentive plan, revising the plan, assessing program effectiveness, assigning salespeople, and resolving disputes. (click to tweet). In 44 percent of organizations, sales leadership is responsible for communicating the plan structure to the field. In 49 percent of organizations, finance bears responsibility for budgeting and performing cost impact analyses of various plan changes.
How to design an incentive compensation plan
Plan creators should take a cyclical, structured approach when developing an incentive compensation plan. The incentive compensation design process should contain four phases: a planning session that begins two to three months before implementation; a diagnostic review of plan performance that includes relevant stakeholders; an implementation phase that clearly communicates all new plans, targets, and accounts gaining buy-in from salespeople; and an ongoing adjustment phase in which plans are re-evaluated and modified based on market or business changes.
Sales teams appreciate certainty and predictability; the more plan creators can follow these guidelines, the more reliable the process becomes.
In addition, successful plan designs tend to be grounded in a few fundamental principles. Before plan creators begin devising the incentive compensation plans, they should review these principles to make sure the plan builds them in:
- Organizational principles. These are about determining how effectively the incentive plan links to larger company goals. What kinds of sales performance is being measured, and how accurate are those measurements? If margin or customer satisfaction, for example, are the key metrics for incentive payouts, how rigorously are they being measured? Other organizational principles revolve around flexibility, and assessing a company’s ability to adapt incentive plans to quickly handle changes in the market, or changes to business objectives.
- Motivational principles. Not all sales people are motivated in the same way. For instance, newer performers may need different drivers than veteran performers do. Plan designers should regularly review the levels of opportunity available to high, low, and on-target performers, and reclassify employees as needed.
- Behavioral principles. This includes multiple parts: the degree to which individual salespeople will be able to deliver against the plan; the degree to which team behavior and performance will be rewarded; and the degree to which the plan is simple, transparent, and comprehensible. Plan designers should be attentive to these different types of behavior, especially group vs. individual behavior, and calibrate their incentive plans accordingly.
Key incentive compensation software features
To effectively manage incentive plans to drive sales behavior, technological solutions should include these key features:
- “What-if” scenario modeling. Sales incentive management technology should offer scenario planning capabilities to keep the incentive plans flexible, helping the business shift quickly to anticipated market changes and business needs. “What if” modeling lets plan creators measure the effects of potential changes before rolling them out to the sales team.
- Rapid calculation time. Best-of-breed technology can calculate incentive payouts in minutes— not days or weeks. Your incentive software should let you automate complex computations, improving the speed and accuracy of compensation data and reclaiming time for value-added activities. It should also ensure data is reliable, which keeps disputes at a minimum and lets you pay out incentives in a timely manner.
- Real-time insights that drive performance. When sales leaders and frontline sales reps have access to real-time performance data, plans can quickly be adjusted to better meet the business goals. An incentive management platform should supply this and other business intelligence, including summary reports and historical audits.
Managing an incentive compensation program
According to Rachel Parrinello, Principal for Sales Compensation Practice at the Alexander Group, the following steps are necessary for keeping an incentive compensation plan healthy throughout the year:
- Ongoing communication. As Parrinello puts it, “In most cases, good communication for a mediocre plan is better than poor communication for an amazing plan.” Importantly, incentive plan communication shouldn’t stop after rollout, nor should it be one-directional. Good communication should come in many formats, including live presentations, FAQ documents, and online resources like training or how-to videos. Communication also means surveying salespeople after plan rollout to see what works and what doesn’t, so that each rollout becomes smoother.
- Reporting. To ensure that plans remain effective, companies should produce reports throughout the year. Reports for different stakeholders should offer different levels of granularity and should include different metrics. (See the next section for more insights on reports.) It’s also crucial that stakeholders throughout the organization all work with the same data, as this helps maintain alignment throughout the organization.
- Post mortem. After the plan has been operational for a few months and tweaked to accommodate feedback, it’s important to convene relevant stakeholders to review what went well in the design and roll-out process and what didn’t. For example, common problems may include the absence of an effective governance model, outdated operational systems, and gaps in the end-to-end process.
- Program updates. The information gathered from the postmortem should be used to reassess the elements that drive your year-in, ongoing plan design and management processes. These may include, for example, better specifying the roles of various stakeholders or more clearly outlining the governance structure for incentive plan management and design.
- Ongoing plan changes. Incentive plans are always susceptible to changes: new company strategies, new acquisitions, product launches, and changes to the customer base. Best-in-class companies handle these by convening steering committees year-round, assessing these potential changes and modifying the incentive plans accordingly.
- Education. Once their comp plans are rolled out, best-in-class companies don’t spend their down-season ignoring it. Instead, they spend their time educating themselves about how to improve their plans: making those plans more effective; achieving better results; increasing buy-in; or reducing unnecessary administrative work. There are plenty of potential educational resources; popular ones include conferences, books, webinars, and certification trainings.
- System and tool upgrades. Most vital to achieving success in compensation management is making sure that your software supports your efforts. In particular, tools need to be able to handle the following data-intensive processes:
- Revenue segments: Incentive payouts are often a company’s biggest expenditure, which is why it’s crucial to forecast them properly.
- Sizing and deployment: Ensuring proper headcount in all regions involves a significant amount of data processing.
- Productivity quotas and metrics: CRM systems are rarely able to model the ebbs and flows of revenue over time or create accurate revenue forecasts.
- Performance management and rewards: This should include but isn’t limited to incentive compensation, accruals, crediting, and a range of incentivizing strategies.
Incentive compensation reporting
Committing to regular reporting is a great technique for keeping an organization’s sales compensation plans functioning properly. It’s equally important that the organization develops protocols for creating different reports for different stakeholders. For example, these five types of reports may be necessary:
- Rep reports. These help reps understand where they stand relative to quotas and helps them sell more effectively.
- Manager reports. These show how a sales team is performing across multiple dimensions.
- Leadership dashboards. These should include high-level metrics around overall performance, pay performance, and cost-to-sales data.
- Plan effectiveness reports. These should be created at the end of each fiscal period, and show in quanitified terms how each compensation plan is performing.
- Admin reports. These should include all the information in the above reports, as well as operational metrics.
What are some methods for optimizing an incentive compensation plan?
If an organization’s incentive compensation plans are not driving the ideal behaviors, three strategies can often help.
- Review incentive plans to make sure that they drive larger business objectives. Many organizations develop sales incentives on a one-off basis to address individual problems. A better approach is to begin by clarifying larger business objectives, then developing plans that motivate those behaviors across the sales force. Organizations can then revise the comp plans as those objectives shift.
- Pay for improvement. Plans that pay people purely for hitting their numbers miss out on the opportunity to pay salespeople and managers for improving. Paying managers for hitting their numbers incentivize them to focus on the number. Paying them for other improvements—getting new reps productive sooner, minimizing no-decisions, decreasing rep turnover, and so on—encourages them to focus on these behaviors, which in turn make the sales team more effective.
- Use software to expand the capabilities of your compensation plan. Today, advanced technology can provide many more options for compensation management, which should encourage companies to develop more robust compensation programs. Compensation plans can motivate different behaviors in different regions, for different products, or for different levels of sales performance. The metrics on which salespeople are measured can become much more complex. Because it can perform complicated calculations in real time, advanced technology can make all of these possible; it’s imagination that limits the capabilities of compensation plans, not technology.
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Why should your compensation plans be connected to other functional areas across the business?
At many companies, managing the compensation plan is an exercise in fighting fires: so many issues arise that simply keeping up with resolving them is a challenge. The best comp plan managers side-step many of these issues by planning for them from the beginning, splitting their time between running the current plan and modeling out future scenarios, using data from other divisions in the company—finance, supply chain, HR, and marketing. Doing this keeps your plan prepared for changes coming down the pike.
Increases to headcount, a focus on a new industry, a revised product roadmap, or revisions to the marketing strategy: these all may necessitate changes to your comp plan, but if you wait until after these events occur to start figuring out how to modify your comp plan, you’ll not only leave your reps confused, you’ll also add unnecessary delays to your company’s sales cycle.
In an ideal state, your comp plan should feel like a living, breathing entity. The way you get there is through active “what-if” scenario planning, constructed from real-time information from other departments in your organization. Doing this may require you to set specific time aside that is devoted to planning for the future. The more you start incorporating information about the future into your day-to-day comp plan management, the more responsive your plan becomes.
How does Connected Planning software help companies develop and manage their incentive compensation plans more effectively?
To be developed and managed in a way that both maximizes individual salespeople’s earnings and advances the sales goals of a company, incentive compensation plans need to be developed using data from across the organization and managed in a way that assesses the impact of potential changes on the rest of the business.
Connected Planning software is invaluable for both of these activities. By connecting the various parts of your organization and making sure all stakeholders have access to the same real-time data, Connected Planning software allows your incentive compensation plans to stay responsive to changes as they occur.
Similarly, advanced scenario planning allows plan creators and plan managers to view all the effects of potential changes to the incentive plans, before those changes are rolled out to the sales team. This allows plan creators and managers to optimize those plans and try out new, innovative ideas.
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