A Beginner’s Guide to Variable Compensation

One of the top reasons people choose a career in sales is the enticing nature of sales compensation plan. Unlike many other professions, sales roles offer a unique blend of flexibility and the potential for impressive earnings through high commissions and variable incentives.

Due to the performance-driven culture around sales, many companies do not offer their sales teams flat salaries.

That's why it's important to understand the different kinds of compensation, why variable compensation plans are so popular both in and out of sales organizations, and how they are used strategically to motivate sales teams.

What you'll learn:

• What is variable compensation?
• Importance of variable compensation in sales
• Types of variable compensation plans
• How does variable compensation work?
• How to design an effective variable compensation plan
• Best practices for managing variable compensation
• Measuring the success of variable compensation plans
• Are there any pitfalls associated with variable compensation structures?

Variable compensation is any part of a salesperson's pay that isn't guaranteed. Base pay — salaried or hourly — is guaranteed, but variable compensation is based on performance. In sales, this typically comes in the form of sales commission.

Salespeople typically earn commissions based on their roles. Pre-sales roles, like account executives and sales development reps (SDRs), earn commission based on the deals they close or the revenue they generate. In contrast, post-sales roles, such as account managers and customer success professionals, earn commission through upselling, cross-selling, and renewing contracts.

Other types of variable compensation include bonuses, which are paid out depending on whether or not salespeople and the company hit certain targets. Equity and spot bonuses are also forms of variable compensation.

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Fixed compensation refers to the portion of an employee’s compensation that does not change based on performance or any other mitigating factors. This typically refers to an employee’s annual salary. The rest of their potential compensation – things like commission and bonuses – is dependent on the employee hitting specific milestones, which is why it is called variable compensation.

Variable compensation is important because it motivates behaviors. By aligning company goals and quotas with individual performance, companies can incentivize the right behavior, including:

• Motivates high performance: When employees know they can earn more by hitting specific targets, they perform better.
• Aligns company goals with performance: Goals like increasing revenue, gaining new customers, and improving retention are better for the bottom line — and ultimately better for sales teams.
• Rewards measurable outcomes: High effort does not equal better outcomes. Variable compensation plans are developed to ensure employees are awarded based on measurable outcomes and performance.
• Encourages accountability: By linking compensation to specific metrics, sales teams have a stronger sense of ownership — and maybe a little healthy competition for motivation.

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There are different types of variable compensation plans that change depending on roles, targets, and company structure.

• Commission-based compensation: Salespeople generally earn commission, which is a percentage of revenue from each sale they close. The more they sell, the higher they earn. Commission-based compensation is best for sales roles that focus on new business, like SDRs, business development reps (BDRs), and account executives.
• Performance-based bonuses: Bonuses based on performance are an example of variable compensation plans that extend outside of sales into the rest of the company. Employees may receive bonuses on top of their base pay after achieving specific targets, which could be individual goals, team goals, or company-wide goals. Salespeople may receive bonuses for exceeding their sales quota or if their company offers year-end bonuses if they hit their targets.
• Equity-based compensation: Equity, like stock options or restricted stock units (RSUs), allow employees to benefit from their company's success if their stock prices rise in the long-term. Equity is often offered to attract and retain talent, and is common in the startup world, where companies may be trying to do a lot more with less.

Many compensation plans – especially for salespeople – include all three of the above types of variable compensation, with each serving its own purpose:

• Commission is most directly to a salesperson’s specific revenue-generating activities, so it motivates them to take actions that help make the company money.
• Performance-based bonuses offer a more general way to reward high performance or behaviors that aren’t necessarily outlined in a salesperson’s commission structure.
• Equity motivates a salesperson by making them feel connected to the overall success of a company; it means that when the company does well, so does the salesperson.

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Here are the three most important steps that represent how variable compensation gets implemented into an employee’s compensation plan:

• Determine pay mix: The employer sets a designated mix of fixed vs. variable compensation – like 70% base salary, 30% variable compensation.
• Establish goals and metrics: Targets are set based on metrics like quota attainment, customer satisfaction, or profit margins. Clarity is crucial — well-defined, measurable goals help align performance to rewards.
• Choose incentive type: Finally, it’s critical to determine what types of incentives will be tied to what goals and metrics. For example, a sales rep might earn commission on the revenue they generate – and also earn a bonus for passing a specific threshold of revenue generation.

Designing variable compensation plans requires a lot of thought and buy-in from across the company. In fact, there are entire teams dedicated to designing comp plans and ensuring their effectiveness.

It's a continuous process that requires collaboration from HR, finance, and sales. HR must set benchmarks, finance aligns the plan with company strategy, and sales works to ensure that the goals are realistic.

For example, finance might want to increase multi-year deals, and in doing so, will propose extra incentives like higher commission. But sales teams, being in the market and knowing the customer, can push back and tweak the goals until they're more achievable.

One of the roles that is uniquely responsible for aligning these goals and crafting compensation plans is that of a sales compensation manager. Typically, these roles marry a background in finance with sales experience, require a lot of data analytic skills, and involve continuously revisiting and updating compensation plans. It can be challenging to design comp plans, not least because of the amount of coordination, but also because the tools used to craft them can be as messy as spreadsheets or as complex as enterprise-level software. Having the right tools, however, makes the job a lot easier, which results in effective, easier to understand plans.

Simplicity is key. The more complicated the plan is, the less likely it is you will understand the behavior you are supposed to drive.

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While there are many different kinds of variable compensation plans, here are the fundamental types, with an example for each:

• Straight commission plans: A salesperson earns a flat percentage (example: 10%) on each deal they close.
• Tiered accelerator plans: A salesperson earns 10% until they hit their quota, and then they earn 15% for all the deals they close beyond their quota.
• Bonus-heavy plans: A salesperson receives a $5,000 bonus for exceeding their quarterly quota by 20%.
• Team-based incentive plans: If the sales team collectively exceeds their quarterly target, each team member receives an extra $2,500.

Keep in mind: while some companies only use one of the above variable compensation types, this is incredibly rare. For the most part, variable compensation plans will include a combination of some or all of the above types.

One of the most important factors of managing variable compensation plans involves modeling and simulating plans before implementing them. The following best practices outline the steps before, during, and after to ensure the best possible outcomes.

Set clear objectives. Define what the compensation plan aims to achieve — are you trying to increase revenue, multi-year contracts, or customer retention? Do you want to do more upselling or cross-selling? Objectives clarify the design of compensation structures, and give teams a north star to follow that supports the company's strategy.

Overly complex compensation plans confuse sales reps and can make it challenging to prioritize the right behaviors. Limiting the number of components ensures clarity. With a base pay set, variables can be mapped out. You might offer a 5% commission on sales, with that percentage increasing as deal sizes increase.

Before rolling out new compensation plans, it's important to model different scenarios using historical data to ensure that plans are good for motivating employees and sustainable for the business.

Companies that are just starting out and lack historical data should engage with a partner that models out the previous year's plans to see what that cost is.

Regular reviews are crucial; consistently adjusting plans ensures they're still aligned with company goals and are encouraging the right behaviors. For this reason, compensation plans should be flexible and informed by performance data and feedback.

For variable compensation plans to be successful, employees need to understand how their pay is calculated. Keeping communication channels open and maintaining straightforward documentation can prevent confusion, while paying commissions accurately and on time builds trust between sales and finance teams. It's also a good idea to give sales reps real-time access to their performance data, usually with the help of dashboards in their sales tools. Above all, make sure you are transparent about compensation changes.

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The success of variable compensation plans can be measured with two metrics: Employee satisfaction and company performance.

• Employee satisfaction: Successful plans should keep employees motivated and engaged. Higher employee satisfaction typically results in higher morale and retention. Regular feedback can help compensation managers understand the sentiment around their plans – that they are fair, transparent, and effective.
• Company performance: Usual KPIs like revenue growth, quota attainment, and profitability can show whether compensation plans are actually helping the sales team hit their objectives. This is where a solid sales performance management plan is key.

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It would be inaccurate to argue that variable compensation comes with intrinsic pitfalls. However, like all aspects of business, mismanagement and unrealistic expectations can result in poor variable compensation packages. Avoid these potential issues:

• Setting unrealistic quotas: If targets are unrealistic or unreachable, employees may be unmotivated and lose trust in their managers. Sales quotas that are too high can result in low morale, high turnover, and poor performance. Conversely, if quotas are too low, employees may not be motivated to perform well, either. If quotas aren't set correctly, sales teams will not be incentivized to embody the right behavior, which can derail company strategy. The key is to find a balance, keeping employees motivated while staying true to company goals.
• Complex compensation plans: The more complicated compensation plans are, the less sales reps know what behaviors are expected of them. For example, having multiple and contradictory criteria like deal size, renewals, and discounts can cause confusion and make it difficult to prioritize and focus on singular objectives.
• Unhealthy competition: Fostering an environment of healthy competition is an important part of managing a sales team, but some variable compensation plans can derail efforts. Ranking employees, for example, can create a toxic environment where employees see each other as competitors versus collaborators, ultimately working to undermine cohesion. This does not mean that employees shouldn't have access to real-time metrics to track their performance, but that managers should be mindful.
• Lack of flexibility: A compensation plan that is rigid and not regularly reviewed can quickly become outdated and burdensome. Businesses change. The market changes. Data changes. Without frequent reviews, dedicated roles, or the right tools, variable compensation plans can fall out of line with company goals and create a worsening employee experience.
• Inaccurate or delayed payments: Delaying commission payments fosters a negative experience for sales reps. Most sales reps rely on variable incentives like commission to account for half or more of their pay. Late payments, or inaccurate payments can result in high turnover and a toxic environment for teams. This can be mitigated by using tools that track and manage compensation.

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Variable compensation plans are relevant to all sales teams, as the majority of sales reps are paid out between a base salary and variable incentives. To be effective, compensation plans must be aligned with business goals and thus should be simple, data-driven, and frequently reviewed. By setting clear, achievable quotas informed by real-time insights, sales teams can stay motivated and successful.

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