Category Archives: Comp Design Principles

Accounts Receivable – good sales comp measure or not?

A/R metrics in sales compensation plans are relatively rare. There is often an impulse to include them from Finance, but in the end the sales leadership usually manages to impress upon Finance the importance of freeing sales people to sell and letting a lower cost resource like an A/R specialist in finance take the lead on pulling in the cash.

That said, it’s useful to recognize that A/R can be attributed to one of two issues: deal terms, or on-time payment. Arguably the sales person has more control over deal terms, and deal terms affect A/R balances. So incentives around selling within the parameters of “standard deal terms” can make a lot of sense if that’s the issue (e.g., slightly reduced commission rate or sales credit for deals sold with non-standard terms). If the issue is late payment then the next question is whether that’s due to non-acceptance of the products/services (quality issues), or just chaos and customer cash retention. If it’s quality issues, then do we really want to penalize sales – they probably have their hands full selling in spite of the quality issues. If it’s chaos and cash retention, then it’s probably better handled by an A/R specialist.

In spite of all those caveats, it is a very solid practice to reverse sales credit for any invoice that is reserved for bad debt based on the company’s policies. This crediting rule has the effect of giving the sales people a real interest in avoiding non-collection, but on an exception basis (without carving out some portion of the incentive at target to fund an A/R metric). Then of course when the bill is paid, the sales credit goes back in for the sales person.

However, if A/R has become a significant issue for the company’s balance sheet then it is often a reasonable metric to put into the plans of sales leadership (not individual contributors). They often are the ones approving non-standard terms. And they can stay on top of the non-collection exceptions and put pressure where it’s needed to help with collection.

What your CEO needs to know about your sales comp plans

CEOs don’t need to understand the details of the sales comp plans, but they do need to make sure that a few things are working correctly. Here’s a check-list for what you should be able to demonstrate to your CEO in your next plan review/approval meeting:

  1. The plans are simple and easy to understand. You can explain them to a high schooler who isn’t math-inclined, and they understand them.
  2.  The sales leaders believe the plans are right, and know how to use them to help manage and motivate their team.
  3. The amount of at-risk pay increases with increasing ability to influence individual measurable sales results. And those with less direct influence over results have less risk and upside in their plans.
  4. All incentive measures are objective and financial, except for those used in sales roles with very long sales cycles (market development, huge contracts…) .
  5. If you ask a sales person what they need to do to really make money on your plan, their answer is the same thing you actually want them doing.
  6. The cost of compensation works in your business model. Over a multi-year period, comp cost per person goes up with the labor market (3% or so on average across the team) while sales volume per person goes up faster (5-25%, depending on the stage of the business). This is because the sales leaders are adding to the selling capacity of each person through great tools, smart organization, leveraging good marketing, the right coverage model and market strategy.

Aggregate cost modeling is essential to ensure the plans create value for the business

ACM

The aggregate cost model projects the cost of the new compensation plans at different levels of business performance, and compares that cost to prior year costs. This simple example also includes some useful ratios of the cost of compensation as a percent of revenue, and per headcount. Depending on the critical business drivers other values may be included in the comparison or scenario creation such as:

  • Gross margin
  • Unit volume
  • Detail by division or product line
  • Specific large customer scenarios
  • etc.
Expected cost of variable pay > total variable pay at target
  • This is an important concept, and often overlooked. If your plans have accelerated payout rates over goal, then the total compensation earned by two people, one at 90% of goal and the other at 110% of goal would be greater than the total compensation earned by two people both at 100% of goal. If you look carefully at the example above, you’ll see that variable pay for “All at Goal” is 48M while the expected cost if the organization hits 100% of its overall goal is 52M. The reason for this difference is acceleration.
  • Another consideration in this modeling is over-allocation of the goals. If the sum of all individual contributor sales goals is 5% greater than the annual operating plan, then average goal attainment of 95% would yield sales at 100% of the organization’s goal. This common practice often offsets the increased compensation from acceleration.
  • But whether these two situations offset each other is totally a function of the shape of the payout curve (and amount of acceleration), the dispersion in performance against goal, and the amount of over-allocation. Only careful modeling will accurately predict the outcome over a range of organizational performance scenarios.

While the summary is relatively simple and usually fits on one page, the modeling and analysis behind it can be quite complex, and includes the results of the incumbent model in which the effects of the new plans on each incentive-eligible individual are modeled and assessed. View a sample incumbent model here.