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Do you know the consequences of a poorly designed sales commission plan or a bad sales incentive plan? In one word, it’s DISASTROUS.
Before we show you the impact with an example, let’s see some stats on why having a good sales incentive plan is crucial for your business.
The case of XYZ Electronics: When incentives backfire
Imagine XYZ Electronics, a fictitious consumer electronics retailer. The company decides to revamp its sales commission plan to increase revenue.
The new plan revolved around one major factor: the number of units sold, with significantly higher commissions offered for surpassing specific sales targets. So, the higher the sales volume, the larger the commission.
The problem of pure volume focus At first glance, the new commission plan appears promising. However, a closer look reveals its inherent flaw. The plan heavily emphasizes sales volume without considering the quality of the transactions or the long-term customer relationships.
What happens next?
The sales representatives quickly realize that the fastest route to higher commissions is to focus solely on pushing as many products out the door as possible.
As a result of this commission structure, undesirable sales behaviors begin to emerge:
❌ Pressure selling: Sales reps start to employ high-pressure tactics to persuade customers to purchase products, even if those don't meet the customers' needs. The focus eventually shifts from understanding customers' requirements to aggressive upselling.
❌ Neglects the post-sales support: The incentive to quickly close deals leaves salespeople with little time to provide post-sales support or address customer concerns. Customers who encounter issues with their purchases are often left unsatisfied, leading to high return rates and eroded brand reputation.
❌ Churning customers: The sales force prioritizes acquiring new customers over nurturing existing relationships. This leads to reduced customer loyalty and a high churn rate.
❌ Unethical practices: To meet their sales quotas and earn higher commissions, some sales representatives resort to corrupt practices, such as misleading customers about product features or hiding information about potential drawbacks.
The domino effect begins, and negative outcomes cascade
The consequences of these undesirable sales behaviors are dire:
The lesson: Always align incentives with values
The XYZ Electronics scenario is a perfect example of the potential repercussions of poorly designed sales commission plans. It highlights the importance of aligning commission structures with broader organizational values and objectives.
✅ A more balanced commission plan that rewards not just sales volume but also factors in customer satisfaction, repeat business, and long-term relationships to prevent the emergence of negative sales behaviors.
✅ A holistic approach to commission plan design, wherein financial incentives harmonize with ethical practices and strategic goals to foster a sustainable and thriving sales culture.
How much do bad sales incentive plans cost
In one word, it’s HIGH.
Let's break this down for you with an example.
Imagine a company that sells software subscriptions. The company has 50 salespeople, and their primary goal is to sell annual subscriptions to their software product. The company's revenue per subscription is $1000, and the average salesperson is expected to close 10 deals per month.
Now, let's consider two scenarios:
👉 Scenario #1: One with a well-designed compensation plan
👉 Scenario #2: The other with a poorly designed incentive plan
1. Well-designed compensation plan
In this scenario, the company has a well-structured compensation plan that motivates salespeople to achieve short-term and long-term goals. Salespeople are rewarded not only for the number of subscriptions sold but also for customer retention and upselling. The plan includes bonuses for meeting quarterly retention targets and upselling additional features to existing customers.
As a result:
- Salespeople focus on building strong customer relationships to ensure retention.
- There's an emphasis on identifying upsell opportunities, increasing the company's revenue per customer.
- Customer satisfaction remains high due to the sales team's customer-centric approach.
- The company's reputation improves, leading to more referrals and new customers.
2. Poorly designed compensation plan
In this scenario, the company has a poorly crafted compensation plan that only rewards salespeople for the number of subscriptions sold without considering customer retention or upselling.
As a result:
- Salespeople focus solely on closing deals to maximize their commissions.
- Little attention is given to customer satisfaction or long-term relationships.
- Customer churn rate increases due to neglecting customer needs after the initial sale.
- The company's revenue per customer remains stagnant.
Calculating the costs
Let's assume that in the well-designed plan scenario:
- Customer retention increases by 10%, reducing churn from 20% to 18%.
- Upselling efforts result in a 15% increase in revenue per customer.
Whereas, in the poorly designed plan scenario:
- Customer churn rate increases from 20% to 30% due to a lack of focus on customer relationships.
- There's no increase in revenue per customer.
Here's how the costs stack up over a year (considering all 50 salespeople):
👉 Scenario #1. For a well-designed incentive plan:
- Initial annual revenue: $1,000/sub x 10 deals/subscriber x 12 months = $120,000/salesperson
- 10% reduction in churn: 0.10 x 0.18 x $120,000 = $2,160/salesperson
- 15% increase in upsell revenue: 0.15 x $120,000 = $18,000/salesperson
- Total annual revenue per salesperson: $120,000 + $2,160 + $18,000 = $140,160
- Total revenue for all 50 salespeople: $140,160 x 50 = $7,008,000
👉 Scenario #2. For a poorly designed incentive plan:
- Initial annual revenue: $120,000/salesperson
- 10% increase in churn: 0.10 x 0.30 x $120,000 = $3,600/salesperson
- No increase in upsell revenue
- Total annual revenue per salesperson: $120,000 - $3,600 = $116,400
- Total revenue for all 50 salespeople: $116,400 x 50 = $5,820,000
This example shows that a poorly designed compensation plan can cost the company over $1 million in lost revenue compared to a well-designed plan. It illustrates how a poorly crafted plan can negatively impact a company's financial performance.
The pitfalls of poorly designed sales commission plans
In the sales world, a good sales compensation plan acts like a compass, correctly guiding your sales force's behavior. While a well-structured sales compensation plan can elevate your organization's performance, a poorly designed one can have catastrophic consequences.
Here is a range of pitfalls associated with bad sales incentive plan design:
1. Short-term focus over long-term strategy
One of the most common pitfalls in sales compensation plan design is overemphasizing short-term objectives. While it's natural to want quick results, relying solely on immediate revenue targets can undermine the long-term sustainability of the business.
Neglecting the bigger picture in favor of rapid wins can compromise customer relationships, hinder innovation, and erode market share.
2. Complexity breeds confusion
In the pursuit of fairness and precision, some organizations create compensation plans that resemble intricate puzzles. However, this complexity often breeds confusion among sales teams.
Motivation and performance can plummet when salespeople struggle to understand how their efforts translate into earnings due to convoluted formulas and obscure metrics. A simple incentive plan design ensures the sales force can quickly grasp the link between their actions and rewards.
3. The one-size-fits-all fallacy
A single, standardized compensation plan may do more harm than good. Different sales roles, geographic regions, and product lines necessitate tailored incentives that reflect each group's unique challenges and opportunities.
Ignoring this diversity can lead to resentment and demotivation, as salespeople feel that their contributions are not being adequately recognized or rewarded.
4. Misaligned behaviors
Poorly designed compensation plans can inadvertently encourage sales representatives to focus on activities that maximize their commissions at the expense of the organization's broader goals.
This misalignment can lead to unethical practices, such as overselling to customers who don't genuinely need the product or service, which can ultimately harm the company's reputation and erode customer trust.
5. Diminished customer focus
One big consequence of poorly structured commission plans is the temptation for sales representatives to employ aggressive sales tactics to maximize their earnings. This can include upselling unnecessary products or services, making promises that cannot be kept, or pressuring customers into making hasty decisions.
Such practices may result in immediate sales but can erode trust and lead to customer dissatisfaction in the long run.
6. High employee turnover rates
Sales representatives are typically results-oriented individuals. If they perceive that their compensation is not commensurate with their efforts, they are more likely to seek employment elsewhere.
High employee turnover is not only expensive in terms of recruitment and training but can also disrupt client relationships and negatively impact the company's reputation. To avoid this, you should regularly review and adjust commission structures to ensure they remain competitive and attractive to top sales talent.
7. Internal conflicts and discontent
When sales commission plans lack clarity or create competition among team members, it can lead to interpersonal conflicts within the sales team. Such conflicts can be disruptive and hinder collaboration, which is crucial for overall success.
Additionally, when team members view each other as competitors, it may result in unethical behavior or attempts to sabotage colleagues to secure higher commissions. A well-structured commission plan should promote teamwork and cooperation while still recognizing individual contributions.
8. Financial instability
Poorly designed sales commission plans can have severe financial consequences for the organization. If the commission structure is unsustainable, it may lead to unexpected financial burdens, such as excessive payout obligations during lean periods or budget overruns.
This financial instability can hinder the company's ability to invest in growth initiatives or respond to unforeseen challenges. To prevent financial instability, you should carefully consider the financial implications of their commission plans and set clear budgetary limits.
The art of designing sales compensation plans
At the heart of every effective sales compensation plan lies a deep understanding of the organization's goals and the behaviors required to achieve them.
A meticulously designed plan considers various factors:
- Market dynamics
- Competitive landscape
- Product complexity
- Sales cycle
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7 Common mistakes to avoid when designing sales incentive plans
The design and execution of a sales compensation plan require meticulous attention to detail and a deep understanding of the organization's goals and the intricacies of the sales process.
Here are a few things to avoid when designing one:
1. Ignoring the strategic alignment
Perhaps, the most fundamental mistake in sales compensation is the failure to align the plan with the organization's strategic objectives. When the commission structure isn't in sync with the broader business goals, sales representatives might pursue activities that yield short-term gains but fail to contribute to long-term success.
2. Focusing solely on revenue
A myopic focus on revenue as the sole metric for compensation can lead to distorted priorities and counterproductive behaviors. When commissions are solely tied to sales volume, salespeople may overlook customer needs, neglect post-sales support, and engage in aggressive tactics to close deals quickly.
3. Overcomplicating the compensation plans
In the quest for precision, some organizations fall into the complexity trap. Complex compensation formulas and convoluted performance metrics can confuse and demotivate the sales force.
4. Following a one-size-fits-all approach for incentives
Sales teams are often diverse, comprising individuals with varied strengths and market responsibilities. A one-size-fits-all compensation plan may need to account for these differences, leading to inequitable rewards and demotivation.
5. Not reviewing and adapting
The business landscape is in a constant state of flux. Failing to regularly review and adapt your sales compensation plan to align with changing market dynamics, organizational goals, and sales strategies can spell trouble.
6. Not getting inputs from the sales teams
Salespeople are on the front lines of customer interactions, gaining first hand insights into market trends and customer preferences. Ignoring their input during the design process can lead to a lack of buy-in and alienation.
7. Failing to communicate effectively
Transparency in compensation is vital for trust and motivation. Failing to clearly communicate the details of the compensation plan, especially how it works and aligns with the company's objectives, can lead to misunderstandings and resentment.
Designing an effective sales compensation plan involves crafting a symphony of incentives, motivations, and business goals. When poorly executed, the consequences resonate throughout the organization, impacting morale, alignment, and, ultimately, the bottom line.
The ripple effect of such a plan goes beyond missed targets—it erodes culture, drains talent, and undermines growth. As businesses strive for success in an increasingly competitive landscape, a well-designed sales compensation plan emerges as an indispensable asset, driving excellence and harmonizing efforts toward shared achievements.