May 30, 2024

Projecting Commission Expense with Accelerated Plans


121Silicon Valley

Accelerated commission plans are a powerful management and motivational tool. But if you don’t plan for them properly, you can have some ugly surprises when its time to write the checks or to explain your results to your investors.

We are referring to what is sometimes called the Snow White and the Seven Dwarfs effect. Consider the impact of an accelerated plan in a company with five sales reps and a corporate revenue target of $5,000,000, where each rep has the same quota and target commission. Here's how those five reps might do under one target achievement scenario:

     Quota Achievement | Commission

Jason        $ 3,000,000  | $ 500,000

Sarah        $ 750,000      | $ 68,000

Marc          $ 600,000     | $ 48,000

Ashley       $ 500,000     | $ 37,000

Greg          $ 150,000      | $ 9,000

TOTAL       $ 5,000,000 | $ 662,000

The good news is that as a whole, the company did fine, hitting their $5,000,000 target right on the nose. But instead of having five reps each earning $100,000 (what reps earn at exactly 100% of the $1,000,000 individual quota) for a total commission payout of $500,000, the total bill for commissions comes to a hefty $662,000. That's $162,000, or more than 3% of revenues, above what it would be given level performance by each rep.

Is this a problem? It shouldn’t be: you should never have expected performance to be evenly distributed across an entire sales force that just doesn’t happen in real life,especially in businesses where big deals are typical. This is a budgeting problem, not a sales management or a cost control problem. But even so, a large unfavorable commission expense variance when sales were right at expectations is pretty embarrassing.

To avoid this problem, its critical that sales and finance work together to estimate what the average sales rep will earn if the company achieves its plan. A key part of that is estimating the probable mix between Snow Whites and Dwarfs. Start with your company’s historical distribution of sales rep performance over the last couple of years. You can also use common sense, based on the experience of seasoned finance and sales managers. Overlaying that likely distribution onto your company’s current accelerated commission plan should give you a clear idea of how much commission expense you should really expect.

Accelerated sales commission plans are a great idea, especially in earlier-stage companies where a relatively small number of big deals make a huge difference. Just don’t find yourself in the embarrassing position of having to explain unpleasant commission expense surprises.