Ask the Experts: Calculating Fair Commission-based Compensation

Question:

I am interviewing for a straight commission-based sales position. I know the product well and my engineering background will give me a big
advantage over other sales people. The products sell for anywhere
between $50,000 and $5,000,000. The sales cycle can be two years. How
should I negotiate my commission and expense account? What would be a
fair commission rate (5%, 10%, 15% on the gross or net)? Should my
contract include a clause that entitles me to a commission for projects
that I’ve worked on even if the sale closes after I leave the company?

First Answer:

You and anyone advising you on this matter need a lot more information. Commission sales jobs are for the very secure and the fearless. Do you have a proven track record in sales and a clear-eyed view of what the job entails? Clearly it’s not a new product because you already know it well. Among the missing data:

1. Is this an existing sales territory, or “key accounts” or “national accounts” assignment? If so, what’s the historical sales volume been? Is it considered an underperforming territory or are you stepping into the shoes of an overachiever who has worked the territory to saturation? The employer is trying to structure a payout to ensure that all sales costs are covered by sales revenues, probably with a pre-determined gross margin target. A “fair” rate will provide you with a reasonable level of earnings if you make quota (for your industry and scope of responsibility); that rate might be larger for a $7 million territory than for a $20 million dollar territory. Good performance-based pay plans assume both an upside and a downside in the quota assigned to you. What are the new challenges to maintaining/growing market share? New competitors?
2. Is this a reconfigured territory, a new territory due to expansion? A new sales channel? In any one of these cases, what are the assumptions that drive the forecast and quota you are assigned? Test them.
3. For an existing territory or across the company, what has the historical payout been as a % of sales? Make sure you aren’t being hired as Wonderwoman or Tarzan, to do the humanly impossible. The impossible could be an unrealistic quota or a purposely unattainable 100% of plan.
4. Are you paid only on closed new sales? What compensation do you earn for maintaining current accounts, or is there no level of service required to do so? Do you earn commission from the first dollar of sales, or only on increases over the current level of business?
5. Is compensation capped? At what? 110% of quota? 125%? 150%? You want it to be uncapped; sell it as “I’ll share the risk, you share the gravy.”
6. Are you responsible for lead generation as well as converting leads to sales? If so, how much of your time is this expected to take? Are you going to be cold calling? Factor in all non-sales tasks into your estimate of this job’s viability.
7. What else besides sales closed affects your payout? Some employers penalize reps who exceed expense budgets, and your expense budget may include use of promotional materials, booth rental at industry conferences, and staff time, not just your T & E.
8. Is the performance of other reps in your region, or the company’s profit level, a factor in your payout? It’s in your favor if you are 100% responsible for delivering the performance that warrants incentive pay.
9. Is there a nonrefundable draw against commission, so you can pay your bills without fear you have to give back unearned advances? Typically the draw is much less than full anticipated commission, sometimes 50%, so you may have to live on $60K a year in a job with earnings potential of $150K, for example.
10. How often is commission calculated and what is the lag between end of the sales period and payout?
11. You can ask for a payout on sales you worked on even if you leave before they close, but you may not get it. If you get such a clause, make sure it defines what level of “work” you have to prove to be eligible; most firms want to reward only the closer or will want to split that commission with those who closed it after you left. Many companies have a rule that you must be on payroll through the end of the cycle in which the deal closes to earn commission. This is why “signing bonuses” originated, to “make you whole” for leaving one employer for another before the end of a sales cycle, and sacrificing commissions.

A few comments: 15% of sales is a big piece of the pie unless it also includes marketing costs or there is very little manufacturing/research/distribution/service cost, unlikely in a highly engineered product. How the company structures compensation shouldn’t be a mystery; open book management builds trust and accountability at every level.

Re expenses, most firms have guidance on level of accommodations and class of air service; every firm has a per-mile reimbursement rate. Most important here, you want clarity on the types and levels of business expenses and entertainment you are expected to incur. Your benchmark should be what the competition does, the norms for this industry, of course within ethical guidelines.

Finally, make sure you have articulated and understand every point of the deal you are entering into. Get it in writing and make sure you interpret it the same way as your management does. Good luck.

Carol Anderson, Career Development and Placement Office, Robert J. Milano Graduate School of Management and Urban Policy at New School University in New York City

Second Answer:

Nothing quite like an easy question when one doesn’t know the risk-aversion/risk-taking profile of a person… It sounds as if you have high expectations for yourself as well as relative to other sales people in your new organization. To answer your questions requires knowledge of the commission structure for the existing sales organization. I’m quite certain that there is a standard plan as well as a superstar plan. The bottom line is to keep in mind that “fair” depends on the margins that the company expects to achieve.

Generally speaking, comp plans are defined based upon: Segmentation(using unique pay plans for those who have direct impact on the top line of the income statement); Differentiation (Pay for Performance); Prominence (Low – essentially order takers where the product speaks for itself… 85%/15% “pay at risk” versus High – the rep drives the sale… 50%/50% “pay at risk”); and Alignment (selection of performance metrics that drive both the individual and the team. Interlocking measures keep everyone focused). As you can surmise, there can be considerable variability in sales comp plans.

As part of the interview process, you should be speaking with sales leaders, sales managers, etc. – ask questions about the comp plans. You should be aware that changing market conditions, competitive threats, and dynamic channel strategies typically cause compensation plans to change. Don’t forget to contact industry associations and talk to them about standard and superstar plans.

Given the potential for a long sales cycle, I might negotiate a percentage for sales cycle milestones – again, talk to your peers and managers during the interview process to identify current comp plans related to long sales cycles (you might also want to discuss a percentage for written and booked business as well as a rider than kicks in for SLAs). I’ve also always been a believer in paying something extra when displacing a competitor.

It goes without saying but before you negotiate anything, be certain you have all the facts – position, line of business, company, industry, etc.

— Steve Levy, Principal of outside-the-box Consulting

Originally posted by alwin