Pay Philosophy: Striking the balance between risk and reward in your sales compensation plans
Payment timing for commission payout can be complex and tricky to get right. You may have heard the horror stories or have seen it first-hand - a salesperson closes a major deal, their company pays on deals booked so the commission is paid out, and then the deal falls through. Equally, if your sales reps only receive commissions once invoices are paid, this could have a detrimental effect on your salesforce’s motivation and time management. So what is the best pay philosophy for your business? Let's take a look at the options.
What is a sales booking?
A sales booking is when a customer commits to spend money with your company, e.g. when a contract is signed or the deal has been considered 'won'. This option of payout is generally better for motivating a sales team and allows them to move on fairly quickly to the next deal, but it does come with more risk. Typically, companies that use a booking payment model, either sell to large, enterprise companies that are stable and rarely default on deals, or sell products or services that are paid at the time of purchase or are on subscription.
- This structure is better for team motivation as it provides an immediate reward to the sales rep for closing the deal. The evidence is clear that causality is a big motivator in sales teams. You can read more about this in our recent blog - The five principles of great compensation plan design.
- Another great benefit is your Sales team will be able to move on more quickly to the next deal. They are focused on bringing deals in as quickly as possible to gain the maximum commissions and are not bound by tracking deals through to the invoice stage.
- It is much easier to calculate and pay commissions for your Finance and Admin teams when compensation is paid on booking. The commissionable event is easily defined in both a manual and automated system and requires no ongoing tracking from sales, finance, or admin teams.
- This structure does provide more business risk and cash flow problems as payment to reps are made before the customer has paid. If you are worried about cash flow, you can set up rules for clawbacks (refunds) where the money is returned to the business from the reps. Read more about clawbacks in our recent blog post.
- However, clawbacks could be demoralising to staff and may increase attrition rates. Transparency is critical for effective sales compensation - so it's important you make it easy for your sales team to follow why clawbacks have been applied, which deal they’re applied to, and the effects on their current payout.
- There can be difficulty in tracking changes to the commission if a customer deal is lost or changes for your Finance team. Although the deal might be out of mind for the sales team, the Finance team will still need to keep track of changes, lost deals and changes to commission payouts. This is where having an automated sales compensation platform can make this process much easier to track and administer.
Cash Based (Invoiced receivables)
A cash-based payout structure releases commissions when the customer pays their invoices. This type of payout is good for early-stage businesses with limited cash flow. It’s much less risky for the organisation and removes the possibility of clawbacks, resulting in a more stable cash flow. It is also suitable for Service businesses as commissions are paid when milestones have been achieved (eg. consultancies, agencies or even services offered by software companies). If customer attrition is high and pricing models vary widely, paying commission after invoices are paid is advisable. Equally, if sales rep attrition is high, you will want to pay commissions when invoices are paid to entice your salespeople to stay.
- This structure is less risky from a cash flow point of view, once the money hits your bank account you can release the commission payment to the sales rep.
- With this payout structure, there is no need to clawback sales commission payments to sales reps., removing a potentially demotivating element of your compensation plan.
- Lastly, your Sales team put more effort into chasing invoices to be paid, resulting in better cash flow for the business but also removes the ability for your sales reps to mis-sell products. This also helps to lighten the load on the Finance department which can be better for smaller businesses that have limited staff or staff covering multiple roles.
- This structure can be demotivating due to delayed gratification. There is not the same high when the deal closes that you would get knowing you were due an immediate commission. Depending on how long it takes for a customer to be invoiced, the sales rep may also need to wait longer for customer support to onboard the customer before they get paid.
- Whilst this one is listed as a pro above, there is also a downside - the sales rep chasing for the invoice payment does take their time away from actual selling. So you will need to weigh up how much time they are spending chasing invoices vs what new business they could be bringing into your business.
- Waiting for invoices to be paid can be time-consuming for your Sales and Finance teams to track and then administer the payment of commissions. You will want to automate this process to make it easier and more transparent using a real-time sales compensation automation tool.
A balanced approach?
A balanced approach is another option. Some companies will opt for a lower commission rate for bookings followed by quarterly or year-end bonuses based on attainment of revenue or invoices paid. Here you would need to strike the right balance between motivation and risk for the business. This will very much depend on what stage your company is at, company culture, appetite for risk and cash flow in the business.
When it comes to commission payout, working out your businesses risk appetite and overall goals will help you decide which pay philosophy will most benefit you. If you are having trouble deciding which payout structure will work the best for your business, the motiveOS team of experts can help with best-practice advice and planning guidance. Contact us today for an obligation-free chat.