October 5, 2009
By Michael Dickstein, associate principal, McKinsey & Company, Tom Stephenson, principal, McKinsey & Co.

Don't Overcompensate When It Comes to Compensation

In this poor economy, salespeople battling fiercely for every deal need to be at the top of their game. Yet with compensation for most sales forces tied to performance, challenging economic times can trap companies into a vicious cycle: Lower sales result in lower compensation, which zaps the energy out of the sales team, making deals even harder to close. Dire times can force companies to consider changes to their compensation plans. However, mid-year changes can throw sales compensation plans out of alignment with business objectives and cost-of-sales targets, especially while companies are trying to reduce expenses. At the same time, salespeople should not be held accountable for truly systemic changes that render compensation plans ineffective.

How do you know when your plan needs to change? The trick is in recognizing signs like the following:

A change in business objectives: Making a dramatic move in the business -- such as changing the focus of the business from new to existing products -- is clearly an opportunity to reevaluate the current compensation strategy.
Revenue below target: Revenue numbers that are significantly below the predicted run rate is another signal for change. This is especially true if the actual sales amount to no more than 80 percent of the target goal. Before taking action, we recommend waiting two quarters to confirm that it is not a temporary slowdown. Such a shortfall can create focus and retention challenges as disheartened reps decide not to invest further in a "lost" year.
Skewed rep performance: Compensation plans are constructed with targets in mind for the distribution of sales quota attainment. A distribution of quota achievement significantly skewed to the left of (i.e., below) what is normally expected could signal a need to adjust compensation plans. Depending on the specific targets, situations where 20 percent or more of the sales force is below the incentive thresholds are strong indicators that change is required.
Median quota attainment and top reps' performance are below previous years: Compare median quota attainment with that of previous years and, specifically, the attainment of top-performing reps. If median attainment is down significantly -- say, more than 10 percentage points -- or if the best reps are struggling, changes to sales compensation may be warranted.
Increase in requests to adjust sales quotas: A moderate amount of quota adjustment requests is normal. Salespeople may want adjustments because of factors beyond their control, such as customer base changes due to acquisitions and shutdowns. However, a significant increase in the volume of quota adjustment requests may indicate a systemic issue.

Once it's clear that change is required, sales leaders have a number of options to consider. The following potential modifications are listed from least to most disruptive to the existing plan.

Introduce a spiff: This can be an effective way to encourage short-term goals or particular behavior changes in alignment with changing business objectives. For example, a technology company leveraged a spiff to reward competitive wins, thereby shifting the focus of the business to market share instead of pure revenue. However, spiffs should not be used to pay for results already in the compensation plan. Therefore, they are limited in their ability to address systemic plan issues.
Reset the performance period: When sales reps feel they will never recover after an especially poor start to the year, motivation can plummet. When most of the sales force has this experience, it may make sense to restart the clock, giving reps a fresh start for the year. For example, after a difficult first half of the year, a software company ended the compensation period, assigned a new quota for the second half of the year, and restarted all reps on this plan. This approach can be especially effective when business is expected to pick up in the near term. If long-term uncertainty is expected, more dramatic changes may be necessary.
Adjust the performance range and incentive rates: If more than 20 percent of reps are below the attainment threshold for incentive compensation, consider lowering that level by about a tenth percentile quota attainment on a year-to-date basis. This change may require a corresponding change in incentive payout rates. One company reduced its threshold level from 60 percent attainment (paying out 65 percent of quota) to 50 percent (paying out 55 percent of quota). As a result, 15 percent of the company's sales reps moved back into the incentive payout range.
Lower the revenue quota: The most dramatic change to a compensation plan is to lower the revenue quota. This change is justified only when the assumptions underlying the quota are known to be incorrect.

During difficult economic times, keeping your sales force motivated and energized is one of the biggest challenges. Ultimately, adjusting compensation is an opportunity to reinforce the company's objectives and demonstrate management's leadership. If done well, the sales force should react with enthusiasm and renewed energy.

About the Author

Mike Dickstein (mike_dickstein@mckinsey.com) is an associate principal in McKinsey's Seattle office. He serves technology clients on strategy and go-to-market topics. Prior to joining McKinsey, he worked in the software industry running sales organizations.

Tom Stephenson (tom_stephenson@mckinsey.com) is a principal in McKinsey's Silicon Valley office. He serves technology clients in software, hardware, semiconductors, and life sciences largely on sales and marketing topics.

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