In the last 2 blog posts, we discussed metrics to include in the incentive compensation plan and the plan types that you should use. Now, we turn to the actual calculation of the payout amount.
Regardless of the plan type that you put in place (e.g., sales commission, quota bonus, etc.), you should start with some key inputs. These inputs come from a variety of sources – such as sales compensation philosophy, plan guiding principles, executive leadership, and benchmarks for each metric.
Here is a sampling of the type of inputs needed to create an effective payout formula:
- % of people who should earn $0 in sales incentives
- Desired incentive paid to the top 10% (as a % of target incentive)
- Any caps
- Sales compensation plan budget
- And others
These inputs will help you achieve parameters to structure the payouts. Regardless of the type of plan you use, these inputs are critical to establish the payout formula.
After considering these key inputs, collect historical performance distributions from the last 2 years. For example, if you had a revenue quota bonus plan in place in 2014, collect the actual performance for all salespeople during that time period. If there is any reason to believe the future performance distribution will differ from the current performance distribution (due to, for example, a new metric, a new product launch, change in sales quota setting method, etc.), then you will need to make an adjustment to the performance distribution, either qualitatively or through other performance distributions.
Now that you have the required inputs and the historical performance distribution, the payout formula comes down to a few key decisions:
|Element||Description||Input this Supports|
|Threshold||Performance below a certain level where no incentive is received||% of people who should not earn an incentive|
|Accelerator Below Quota||Increased rate of pay between threshold and sales quota||Limiting the payout to bottom performers|
|Accelerator Above Quota||Increased rate of pay above sales quota||Ensuring top performers earn adequate incentive|
|Cap or Decelerator||Mechanism limiting rate of pay above a certain performance level||Maximum payout and total plan cost|
This covers the basics of payout formula creation. Of course, there is a much more elaborate discussion to be had if the payout formula includes complicated elements such as linked metrics, kickers, hurdles, and matrices. But this should provide the basics of how payout formulas are designed to arrive at best-in-class pay for performance statistics.