Incentive compensation management: A primer on driving sales performance

For modern sales forces, offering base salary alone can fail to inspire the high levels of effort, persistence, and creativity needed to close deals and generate significant revenue.  

This is where incentive compensation comes in.  

Incentive compensation (done right) is a catalyst for increased productivity, and fosters a sense of urgency and purpose among sales representatives. It directly links individual performance to financial rewards and a company's overarching success.

It's cited by Falcon Incentives that, a well-structured incentive program can lead to an average uptick in productivity by 25%.

The flexibility of incentive compensation plans allows organizations to adapt swiftly to ever-changing market conditions, making sales compensation a dynamic and effective way to drive performance.  

Further, top-performing sales professionals are attracted to companies offering lucrative incentives and are more likely to remain with organizations that consistently reward achievements.

In this explainer on incentive compensation management (ICM), we'll walkthrough the benefits of a well-designed program, the key challenges faced by organizations today, and how we recommend approaching the design of effective ICM plan.

What is incentive compensation management?

Incentive compensation is the additional reward given to employees beyond their base salary for achieving and surpassing performance and productivity goals. This is most common for sales teams, where sales representatives are compensated based on their activities or the financial results they bring to the business.  

Incentive compensation can account for approximately 15% of top-line spending in organizations (a significant budget item) and, when executed correctly, can be a powerful lever for generating revenue.

While specifics vary between companies, incentive compensation typically includes elements including a base salary, commission, and other incentives aimed at driving the specific performance of a sales organization.

At Forma.ai, we view Incentive Compensation Management (ICM) in two interconnected but distinct functions:  

1. The strategy and design of your incentive compensation scheme, and  

2. The processes and workflows for tracking, calculating, and administering the program.  

Both functions need to work in total harmony to achieve optimal and desired outcomes from your incentive program.

The benefits of a well-designed incentive compensation management system

While there are many benefits to incentive compensation, let's cover the top three advantages of this investment in sales performance management.

1. You can align sales activity to core business growth objectives

Incentive compensation ultimately aligns representatives' activities or behaviors with a business's strategic goals. By structuring compensation around specific, high-impact actions—such as closing certain types of deals, acquiring new customers, or promoting key products or features—sales reps are motivated to focus on what your organization has determined via data, truly matters.  

This targeted approach ensures sales efforts directly contribute to the company’s priorities, minimizing wasted time and resources on non-revenue-driving activities. Optimized incentive comp helps you positively direct sales output and effectiveness.

When sales reps concentrate on actions that directly influence revenue growth and market expansion, the company sees improved customer acquisition and retention rates. This strategic alignment creates a cohesive effort across the organization, driving sustained growth and competitive advantage.  

2. Effective ICM improves employee motivation and engagement

At the end of the day, Sales can be a grueling, difficult grind.

Sales reps with long, enterprise sales cycles are constantly pushing boulders uphill, facing rejection, pushed out timelines, lots of grunt work, and more. High-performers persevere despite the ups and downs but, all the same, incentive compensation and fair, balanced quotas and territories ultimately help to keep sales teams motivated and engaged; sales incentives provide a reward for perseverance and enable more autonomy and control over earnings.  

Besides enhancing individual performance, incentive compensation promotes a competitive yet collaborative environment within sales teams. When team members know their efforts amount in tangible rewards, they're more likely to share best practices among the team, support each other, and collectively strive for organizational excellence. This collaboration increases overall sales productivity and job satisfaction among a more cohesive team.

3. Organizations can enhance employee retention and recruitment

Lastly, a well-structured sales compensation plan ensures you can recruit top-performing sales personnel and reduce turnover.  

Businesses that create attractive sales compensation plans ultimately give the best talent a reason to accept a position on the sales team and stay with the company in the long term.

According to Falcon Incentives newsletter stats, organizations with transparent incentive schemes have an 80% retention rate. And (within the same newsletter), 60% of high-performing employees are found in organizations that routinely reassess and adapt their incentive programs.

Avoiding the potential pitfalls of poorly designed ICM plans  

Effective incentive compensation management also entails vigilant risk assessment. Keep tabs on potential risks associated with your compensation plans, such as over-reliance on a single metric or unintended consequences that might arise. Regularly analyzing these aspects will help you mitigate risks and maintain the integrity of your incentive programs.  

While incentive compensation programs have their benefits, they come with a set of challenges that can hinder their effectiveness if not properly addressed.      

A significant hurdle for many organizations is managing the complexity of incentive plan design. The intricacies involved in setting the right performance metrics, thresholds, and payout structures can be overwhelming. Without access to a sophisticated tracking system and robust data to inform decision making, it’s easy to lose sight of essential KPIs and short-term and long-term objectives.     

How you'll know you're running an ineffective incentive compensation management approach...

Organizations typically feel the painful symptoms of a poor incentive compensation program acutely. Sub-optimal incentive compensation planning and execution, results in:

• Misaligned seller behaviors

• Overlooked revenue opportunities, and

• Diminished confidence among sales teams regarding the connection between their efforts and financial rewards (this will look like high sales team turnover).

Your organization must strike a delicate balance between incentivizing to achieve ambitious targets and ensuring your compensation strategy aligns with broader business objectives.

‍Challenges and solutions in incentive compensation management

The emergence of incentive compensation management software several years ago helped organizations solve for mission-critical pain points; largely in administering sales compensation. ICM software provides advanced calculation capabilities, automates complex incentive schemes, and provides a level of transparency to sales teams that was otherwise previously unavailable.  

The first iteration of these solutions helped businesses and sales compensation teams:  

• Reduce errors and time-consuming effort to calculate ICM. By accurately processing data inputs and eliminating manual, error-prone tasks, these tools helped ensure precise and timely payouts.
  

• Improve payout visibility and transparency to the sales team. With real-time dashboards and detailed reports, these tools enabled sales teams to track performance and earnings accurately and transparently.

While some companies are further along their ICM automation journey than others, many still suffer from the biggest pain point and challenge outstanding in ICM today: agility.  

Achieving organizational agility (or the ability to keep pace with changing market trends by rapidly adapting incentive strategies) is challenging due to several factors.  

1. First, many traditional ICM systems are rigid and lack the flexibility needed to adapt to changing business environments and strategies. These systems often require extensive customization, which can be time-consuming and costly.  

2. More importantly, integrating sales compensation software with existing IT infrastructure can be complex, leading to potential compatibility issues and data silos. Siloed data like this means that every time a new incentive change needs to be modelled, there is extensive work required to get data into a usable format, and then further work to implement these changes into ICM.  

This lack of agility and siloed data means that despite ICM software existing to help automate sales compensation, organizations still have suboptimal plans that don’t align with strategy, or costly plans that overspend for incorrect outcomes.  

Here at Forma.ai, we are accelerating SPM for enterprise companies by unifying planning and execution for incentive compensation management (ICM), as well as territory and quota management (TQM)—all in one comprehensive platform.

Here's a look at why sales and revenue operations teams trust us for both sales planning capabilities and incentive compensation:

Developing a market-leading ICM program

To start, many organizations often first solve for base-level administrative challenges like payout errors and visibility. That said, once the essentials are covered, it's critical to scale with more sophisticated capabilities. Namely, unlocking a new level of agility around sales planning seasonally, and any-time updates to your plans. This realistically requires adoption of robust ICM or sales performance management (SPM) software.  

A full-stack SPM solution helps organizations rapidly create, optimize, and deploy incentive compensation programs, and gain infinite flex capability of in-house compensation teams.

Your business needs the flexibility to both design and optimize incentive structures every time a strategic need arises (e.g. sales team restructuring, strategy acquisition, product launch, etc.), all the while implementing and tracking plan updates or refinements effectively.  

Before we cover the necessary steps for how to design a market-leading ICM program (at the highest level), let’s level-set on some key definitions and components of incentive structures.

Key components and terminology of incentive compensation plans

An effective incentive compensation plan encompasses several key components:

• Plan type: A plan type establishes the overall framework, such as commission-based or bonus-based schemes.  

• Pay mix: this describes or defines the balance between fixed salary and variable incentives. A pay mix ratio helps ensure stability while also motivating high performance.  

• Rate structure: This specifies how incentives are calculated, often using tiered rates to reward higher achievements. What's known as a 'payout curve' illustrates the relationship between performance and earnings, showing how compensation increases with improved results.

• Number of plan components: This number should be manageable to keep your organization's plan straightforward and understandable, typically including base salary, commissions, and bonuses.  

• Metrics: The metrics that the plan is measured against are crucial, detailing the performance criteria like sales volume, new customer acquisition, or product-specific targets that qualify for incentives.  

• Period: Plan period defines the time frame for measuring performance, such as monthly, quarterly, or annually, ensuring timely and relevant rewards.  

Together, these components create a cohesive and motivating compensation plan that drives sales effectiveness and aligns with business objectives.

The 5 steps involved in designing effective incentive compensation plans

Below are the fundamental steps involved in designing an effective ICM plan.

1. Understand your business objectives and market

First, clearly define the objectives of the plan. These may be organizational goals including:  

• increasing sales volume,  

• entering new markets, or  

• promoting specific products.  

These goals should be measurable and aligned with the company’s strategic priorities.  

2. Tailor plans to different sales roles

Next, select the appropriate plan type, whether this is commission-based, bonus-based, or a hybrid, to match the company’s sales structure and market conditions. In this step, the pay mix, balancing fixed salary and variable incentives, should be designed to provide financial stability while motivating top performance.  

Depending on the nature of the sales role, the pay mix may over or under-index on its aggressiveness (i.e. typically ‘hunter’ acquisition roles have a higher variable component than ‘farmer’ account management roles).  

3. Assign metrics and components

Based on the business objectives to be achieved, here, you'll choose relevant performance metrics that reflect key business drivers, such as revenue, customer acquisition, or product-specific sales.  

You'll want to limit the number of plan components to maintain simplicity, typically including base salary, commissions, and bonuses. Best practices suggest no more than 4 plan components (or any plan component contributing to no less than 25% of variable earning potential).  

4. Set rate structure and payout curve

In this step of ICM planning, establishing the rate structure is vital, often incorporating tiered rates that reward higher levels of achievement.  

This structure needs to be transparent and easy to understand, so employees know exactly how their efforts translate into earnings. Your sales compensation team ultimately designs a payout curve that illustrates how compensation increases with performance, encouraging reps to exceed their targets.  

5. Set the payout periods

Lastly, sales compensation teams align with sales leaders to define the period for performance measurement, whether this is monthly, quarterly, or annually, to ensure timely and relevant rewards.  

Below are some key considerations when defining your payout period:  

• Business cycles and sales strategy: Align payout periods with the natural business cycles of your company. I.e., if your industry has quarterly sales peaks, quarterly payout periods might make sense.

• Sales cycle length: Consider the average length of your sales cycle. Shorter cycles may benefit from monthly or quarterly payouts to keep sales representatives motivated and continuously engaged. Longer cycles might necessitate semi-annual or annual payouts to reflect the time required to close deals.

• Cash flow management: Aligning payout periods with your company’s cash flow can ensure financial stability. Frequent payouts may strain cash flow, while less frequent payouts can help manage finances better but might demotivate sales teams if they have to wait too long for their earnings.

• Motivation and engagement: Shorter payout periods can keep sales representatives consistently motivated by providing regular rewards for their efforts. However, combining them with longer-term bonuses can balance immediate gratification with long-term goals.

• Market norms: Consider industry standards and what competitors are doing. Aligning your payout periods with market norms can help attract and retain top talent who expect similar structures.  

Once you have your initial incentive plan structure developed, you can begin modelling your plan to predict what the financial impact will be to the business and individual sellers. This will be an iterative process whereby you may tweak variables identified in the steps above to adjust the expected outcome.  

During the plan design process, it is often helpful to establish a sales compensation committee comprised of key stakeholders that have a vested interest in the eventual plan design. Typically this may include stakeholders from Sales, Sales Operations, Human Resources, and Finance. Creating this Braintrust in your org ensures that the design process is collaborative and results in an incentive comp plan that reflects all the different priorities within a business.  

Best practices for implementing effective incentive compensation plans

Once the incentive plan has been designed and buy in has been achieved from all appropriate stakeholders, the new plans can be deployed to the sales team.  

Considering the complexity, this change management exercise is worth its own detailed step-by-step guidebook, but at a high-level the most important things you need to do include:  

Over-communicate and give transparency

Implementing a new sales compensation plan requires clear communication and transparency.  

• Begin by explaining the plan’s objectives, structure, and benefits to the sales team.  

• Provide detailed documentation, host training sessions, and maintain open channels for questions.  

• Regularly update and involve the team to ensure understanding and engagement.  

A comprehensive approach to the comms plan will help create a compensation plan that actually drives performance and supports the company’s success.

Leverage automation and technology

ICM and SPM tools have been purposefully developed to help automate incentive compensation calculations and provide reporting and performance tracking for sales teams and leaders.  

Finding a solution that's flexible enough to handle your unique plan requirements and data, but easy to configure and manage will help ensure you get the most out of your platform.  

To ensure widespread adoption, provide training on your ICM or SPM tools internal, and leverage the data analytics within these powerful platforms to continuously optimize and adjust the plans and individual understanding of performance to goals.

Don't set and forget: Ongoing monitoring and adjustments are crucial

The only constant in sales compensation is change. Eventually your plans will require tweaks and constant alignment to business strategy as it evolves throughout the year. To proactively ensure  your plans are driving intended results, set regular check-in points to review plan performance both quantitatively and qualitatively.  

This includes measuring plan and performance metrics through analytical tools and comparing results against goals. This also includes gathering feedback from sales teams, and managers to ensure compliance to the plan.  

Continuous monitoring ensures the plan aligns with business objectives and drives desired outcomes effectively.

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