How To Design A Reward Structure That Works

July 13, 2016 Geoffrey Walters

‘You must be in tune with the times and prepared to break with tradition,’ said the American writer James Agee—but often, that’s easier said than done, especially within monolithic, long-established companies that find change very difficult.

As salespeople, we’re all familiar with the traditional reward structures employed by businesses. In its simplest form, it boils down to you make quota, you get commission. But there is increasing evidence that, in modern companies, this type of system just doesn’t wash.

 

Why We Need To Be Wary Of The Old Model

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The U.S annual spend on bonuses and incentives as of 2012 was $38 billion a year, and it’s safe to say that figure has increased in the four years since. Jason Lemkin says SaaS sales staff typically take home around 20% ACV. Build too much of that as base salary and you incentivize ineffective reps to coast. Make too much of it bonus and you risk losing out when your reps succeed, as well as making their income too insecure. The result is that sales reps’ compensation on what Lemkin calls the ‘BigCo comp plan’ can ‘seriously wreck your economics.’

The promise of monetary reward has always been a way of motivating employees. But it doesn’t always work out that way.

Not only can a poorly designed commission structure fail to provide proper motivation, it can even put the company’s future at risk by destabilizing its finances.

‘Unfortunately, when designed poorly, incentives can put a company’s sustainability at risk by paying out too much, incentivizing the wrong behaviors or possibly driving people to game the system to meet their targets,’ writes Chris Cancialosi in Forbes.

‘Incentives that may appear completely rational to leaders can have the unintended consequence of rewarding bad behavior.’

 

How Do I Assign Commission?

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A good blend of basic wage and commission is necessary—and what works for one company doesn’t necessarily work for another.

Dennis Dresser of the Anaplan website outlines the two basic options open in terms of commission models. Firstly, there is the low basic wage, high commission option:

“This option positions the salesperson as master of their own destiny and paycheck; they have control over their earnings,” he writes. “However, it could mean that some are working around the clock to scrape a decent wage together.”

The alternative is to offer a high basic wage and low commission, which gives peace of mind—but may lead to complacency on the part of the salesperson. “While more secure, this also has a downside,” writes Dresser. “Will well-paid salespeople feel less motivated to stretch themselves?”

If you do take the commission approach—as most companies do—Dresser suggests capping commission so that you can effectively budget. Again, where you place this cap may have an effect on your sales team’s motivation, so consider this carefully before deciding on a figure.

 

An Imperfect System

As Richard Bayston pointed out on these pages in February, there are a number of imperfections with the traditional commission system. Any number of factors that are completely beyond the control of a salesperson can affect their ability to close a particular deal.

Unforeseen events like the rep’s contact at the target company no longer working there, sudden budgetary constraints on the part of the prospect or a change to the tech environment can ruin a deal through no fault of the salesperson. Likewise, serendipity can intervene to hand someone a sale on a plate, with their role in the persuasive process completely incidental.

One salesperson gets a nice, juicy commission while the other does not—and yet neither rep has had one iota of influence on the outcome. As Bayston acknowledges, when a deal falls through in this way, reps are being punished for bad luck.

Likewise, when they hit numbers for reasons outside of their control, they’re being rewarded for luck—and this type of commission system has a hugely destabilizing effect on the business.

‘Issuing rewards and punishments at random is how you teach people to be disoriented, disorganized and helpless,’ writes Bayston.

 

Two SaaS Commission Models

Bayston’s solution to replacing this outdated reward structure is simple: ‘[T]ie [a rep’s] compensation to their actions—and build a path of actions that leads to results, for them to follow.’

What Bayston is talking about is giving the company reps a clear indication of how their actions affect the business and rewarding these actions accordingly. It’s in keeping with an across-the-board change of climate in modern business—and an ideal model for SaaS businesses.

David Cummings of SaaS company Pardot suggests two common models. The first is the model Pardot initially went for, which is all about understanding customer churn—i.e. the loyalty rate of customers. Pardot made their reps aware of the length of time customers required to develop a loyalty to the company—and rewarded them if they managed to convince clients to stay for that length of time.

‘We quickly learned that, if a customer stayed with us past month four, they’d stay with us indefinitely (we had a monthly customer churn of 1.4% with no contracts),’ writes Cummings. ‘So, naturally, we set our sales compensation plan based on this learning about the critical nature of the first four months.’

‘Sales reps were paid a commission of 50% of monthly revenue for the first four months. We wanted the reps to sell good-fit customers, and if the customer churned after the first month or two, the sales rep would get a substantially reduced commission.’

Cummings discovered that HubSpot had started off with exactly the same model—but then tweaked it slightly to come up with an even better method of linking rep performance to the company’s overarching goals.

‘Over time, HubSpot evolved to a different formula that did a better job of promoting good-fit customers,’ he writes. ‘By paying half the commission in the first two months and then spreading the commission out over two key junctions - the six - and twelve - month milestones — HubSpot was able to align the sales team with the company goal of signing customers that were great fits.’

 

A New Reward System For A New Era

So we’ve got commission nailed down. But in the modern business environment, commission in and of itself isn’t enough to define a reward structure.

The increasingly nebulous divisions between leaders and employees—driven in part by the rise of the startup-style ‘flat hierarchy’ system—has seen a change in expectations from employees in terms of what they demand in a company.

A recent Deloitte study of challenges regarding staff in business—Deloitte Human Capital trends 2016—showed that the number-one issue on business leaders’ minds is how to redesign their organizational structure to meet the demands of the workforce in the current business climate.

The report was analyzed by Josh Bersin in Forbes.

‘The conclusion, after almost a year of study,’ writes Bersin, ‘is that today’s digital world of work has shaken the foundation of organizational structure, shifting from the traditional functional hierarchy to one Deloitte calls a “network of teams.”

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The impact of this, according to Bersin, is nothing short of seismic.

‘This new model of work is forcing us to change job roles and job descriptions; rethink careers and internal mobility; emphasize skills and learning as keys to performance; redesign how we set goals and reward people; and change the role of leaders.’

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In fact, 92% of the companies surveyed by Deloitte said that ‘redesigning the way we work’ was one of their key challenges. But what advantages does a network of teams give us?

 

What Is A Network Of Teams — And Why Is Having One Desirable?

A network of teams is a system whereby teams are coordinated, aligned, share information and work together—but the key thing here, when it comes to reward structure, is how to properly reward people in an environment with little precedent in the business world.

‘The problem we face, however, is…how we move people and reward people in a company that no longer promotes upward mobility and power by position in leadership,’ writes Bersin.

The focus now has to be on the sharing of information, the development of a good corporate culture and collaboration. ‘We have to think of companies like Hollywood movies,’ writes Bersin. ‘People come together and bring their skills and abilities to projects and programs, they build and deliver the solution, and then many of them move on to the next “movie” later.’

Deloitte’s research identified four keys to success: shared values and culture; transparent goals and projects; feedback and a free flow of information; and the recognition of skills and contribution rather than position.

It’s the fourth of these that is important when we try to design a functioning reward structure. ‘The days of positional leadership are going away (i.e. “I’m the boss so you do what I say”) to be replaced by growth and career progression based on your skills, alignment with values, followership, and contribution to the company as a whole,’ writes Bersin.

‘Artifacts like organization charts, job descriptions, performance appraisals and career paths are being invented, redesigned or even thrown away before our eyes.’

 

Reward The Team, Not Just The Individual

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It’s not just the skills and contribution of individuals that drives a good reward structure, however. An Aberdeen Group white paper showed that ‘“best-in-class” firms were more than twice as likely as the so-called “laggards” (59% v 29%) to have a compensation system that recognized both individual achievements and team or company accomplishments,’ as noted by Anaplan on their blog.

 

Incentivize Good Behaviors

‘If reps get the same payout for closing a one-year deal as [they do for] a three-year deal, why would they ever push for longer terms?’ writes Cara Hogan on Ramp, the InsightSquared blog. ‘[Y]ou know that the longer contract offers more stable revenue for your business, which is something you’d like to encourage.’

Hogan suggests tailoring a scheme to those outcomes, rewarding reps that close deals with no discounts, multi-year contracts, upselling potential and up-front payments. This both makes the salesperson aware of the company’s business priorities and removes the incentive to take the easy route to sales by giving clients underpriced, short-term deals.

 

Non-Cash Rewards

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Remarkably, cash incentives aren’t always motivating as we think. In his piece for this blog, Richard Bayston gave the example of the New York cabbies who would quit early on rainy days—not because they didn’t like being out in such weather, but because the number of people taking cabs rose, they hit their quota earlier—and then knocked off for the rest of the day. They didn’t stay on to make more money.

Similarly, salespeople may be inclined to relax once they’ve hit quota. What will motivate them to do better is our love of luxury and our need to be recognized and praised for our good work. UCLA and MIT studies found that people preferred tangible rewards to an equivalent cash amount.

In addition, non-cash rewards in a business setting are, on average, around 60% cheaper than cash rewards, according to the Aberdeen Group. Not only could you make your sales reps happier by implementing non-cash rewards, you could be saving your business a ton of money at the same time.

 

Make It Understandable

Keep it simple. In sales, we return to this point so often that it’s almost become a mantra—but that’s because so many people needlessly overcomplicate things that are, in reality, incredibly straightforward.

A good rewards system should be simple—simple enough to be easily understood by employees. No one wants to develop hugely complicated rewards structures but it’s easy to do it by accident, struggling to account for a complex marketplace by ticking every box.

‘The worst thing you can do is create a compensation plan that is so complex, your reps can’t immediately understand their own pay,’ writes Cara Hogan. ‘Because of all these variables in SaaS, it’s easy to start adding in all sorts of variables and tiers within the plan.’

‘As you build out your company’s comp plan, make sure it remains easy to follow.’

As James Agee suggested, it’s time to get in tune with the times and break with tradition. Follow these tips and you won’t regret it.

About the Author

Geoffrey Walters

A serial entrepreneur and digital nomad, Geoffrey has been running his own marketing consultancy for the past year.

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