Incentive compensation management overview: why it's important and how to structure a compensation plan

What is incentive compensation?

Creating coverage models and building sales incentive compensation plans are often the first two things when businesses start sales programs.

The reason is simple: incentive compensation plans are essential in aligning reps with business goals and driving sales performance.

Yet without a sound, reliable system and structure for rewarding reps, it can be challenging to attract, motivate, and retain top performers. Not only can this negatively impact sales numbers, but it can also slow the overall progress of your sales organization and the company's ability to produce meaningful returns. 

Incentive Compensation Management (ICM) is essential in designing, deploying, and adapting effective compensation plans and workflows. 

According to Gartner, ICM software must be able to handle the complexities of crediting and compensation rules, as well as process large volumes of data quickly. This creates operational efficiencies that ensure you spend less time working through the finer details and more time focusing on the big picture as your company evolves and scales.

Understanding the difference between total compensation, incentives, and incentive compensation is the first step in developing a good compensation plan. Clarity on these terms helps assign and standardize the various types of pay and benefits. 

Some definitions:

Is incentive pay a bonus?

Incentive pay (or “incentives” for short) are a form of compensation rewarded based on performance. They are often leveraged to motivate employees to meet (and exceed) quotas and goals.
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Bonuses may be granted more liberally and are typically one-time, lump sum payments.

While some use “bonus” and “incentive” interchangeably, they are not always the same.

Bonuses are a type of incentive. But not all incentives are bonuses.

How is incentive pay calculated?

There’s no standard incentive calculation formula. Different businesses reward sales reps based on different sets of criteria. 

That being said, incentive pay is most frequently calculated as a percentage of sales. 

Some examples:

‍Simple plan: A rep has a $20,000 per year sales quota with a 10% annual commission. The incentive payment is $2,000 (10% of $20,000).

‍More complex plan: A rep’s incentive plan is 15% of total quarterly sales. Unfortunately, their first-quarter sales were only $10,000. Their additional comp would be $1,500 (15% of $10,000).

Smaller sales teams (fewer than 15 reps) often use an incentive formula in Excel to calculate commissions. 

Larger teams? Automation!

CaptivateIQ makes it easy for users to calculate incentive pay and automate manual processes for greater efficiency — reducing data entry errors and freeing up admins’ capacity to focus on what matters most: designing compensation plans that deliver results.

Back to the basics: learning how to create and launch an incentive program

You understand the key terminology and are ready to start an incentive program at your organization. 

Not quite … creating a successful incentive compensation program also begins with knowing your employees and the types of incentives they would find meaningful. 

Your goals and your workforce's needs are essential factors in determining what kind of incentives you should offer, but so is the type of company culture that already exists.

This means you must take steps before writing up a budget for this new initiative. You'll need to:

• Observe the behaviors of your employees that you want to encourage and how those actions are currently being recognized (or not)
• Clarify what it is you want from them, so you can identify behaviors that will help achieve those ends
• Identify how your employees' work or performance can be quantified, so you can assess their performance using metrics that make sense for your company

Once you've answered these basic questions, then it’s time to start designing the structure of your incentive program. Reviewing examples of incentive programs can be very helpful as you begin to set up your plan. 
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Here are a few: 

• An Annual Incentive Plan is a type of pay plan that rewards employees for achieving specific goals.
• Unlike regular compensation, a Performance Incentive Program  rewards reps based on ... you guessed it ... performance. This typically plays out as a base salary with additional compensation tied to hitting (or exceeding) predetermined goals and targets. 
• A Motivational Incentive Program may offer gift cards, tickets to shows and sporting events, or even travel coupons. These are all examples of motivational rewards that can be leveraged to incentivize sales reps, encouraging them to do their best and continually set higher goals. 

While incentives can be an excellent tool for motivating reps, it’s critical to first:

• Develop a solid framework for how incentives are tied to the broader business goals. This ensures fairness and alignment from the start.
• Define the terms and parameters of the program. This includes how goals and milestones are set, how progress is tracked, and what to do if a goal or milestone isn't met. Clarifying even the most basic terms establishes the foundation for how an incentive compensation program can be successful.

Let’s clarify a few more terms you are sure to see moving forward.

Sales incentive model vs. compensation structure

A sales incentive structure differs from a traditional compensation structure in that it’s primarily designed to motivate and reward. 

Incentives are not a mandatory form of payment by the employer, nor is it a given bonus for the employee. Sales incentives are only earned when you hit a specific target or bump into a predetermined tier.

Within a standard compensation structure, reps may receive mandatory payments like base salary every week or month. On the other hand, incentive structures are based on performance and are completely variable. 

Incentive compensation model vs. incentive compensation plan

An incentive compensation structure is a broad framework that guides an incentive management program. For instance, your structure might state the exact sales amount reps must achieve to earn a certain percent commission. In addition to calculations, most structures detail the general targets or standards that must be met to earn incentives.

Incentive plans are often tailored to individual reps, outlining specific goals for each person. Unlike a broader, all-encompassing framework, an individual plan can be tweaked and customized according to each rep’s performance, taking their unique needs into account.

Incentive plan examples and best practices

There is no shortage of incentive plan examples. But what are the characteristics of the best incentive compensation plans? What precisely should you aim to achieve when developing group or individual plans? 

While there is no right or wrong answer, here are a few things to consider when developing an incentive plan:

• Metrics may be as simple as a “bonus” if the company meets a specific goal (i.e., increasing revenue by 10%) or more complex, such as paying based on individual or department performance. 
• Determine the frequency of incentives. Looking to reward reps for their performance over a shorter period? Check out short-term incentive plan examples for ideas. Reward reps for several quarters or annually? Consult some long-term incentive plan examples. Whether you’re optimizing incentives for the short or long-term, the building blocks of successful plans are generally the same and involve five components: eligibility, pay levels and mix, upside, performance measures, and mechanics.
• An incentive plan often mixes short and long-term targets. For example, most commission-based salespeople have a base salary that provides a foundation – something to fall back on, a base. The short-term goals are often tied to performance metrics like the number of units sold in a specific period, customer satisfaction scores, or delivery speed. These metrics are relatively easy for salespeople to control directly. The long-term targets typically involve some sort of financial metrics such as gross margin or total revenue for a given period.
• Incentive plans with short-term goals are built on the idea that people are motivated by instant gratification — “if we work really hard to get to the goal as fast as possible, then we'll be able to relax.” But this is a very surface-level way to look at motivation: it doesn't take into account factors like job satisfaction and pay transparency. In fact, sales reps (92%) believe clearer visibility into compensation is a strong motivator, yet roughly a quarter have access to real-time insights. It’s critical to administer plans properly so that salespeople know how they tie back to their own performance and roles in the organization!

A well-designed incentive compensation plan can encourage employees to give full effort. A poorly-designed plan can have the opposite effect, encouraging employees to slack off or even sabotage the company's goals. 

But compensation plan design is tricky because one size doesn’t fit all. Structuring an effective plan depends on various factors, including the products or services you sell, your business objectives, and your industry.

Sales incentive plan templates with the commission formula

Manufacturing

Commission rates vary depending on the sector. For example, commission rates may be as low as 3% (for supply chain) to as high as 10% (for heavy-duty equipment).

Software/SaaS

The rate of commissions for software companies varies based on the product or service sold. For example, commission rates may be as low as 5% for marketing solutions to 50% for customer relationship management tools.

Medical Device

Sales reps for medical devices are often offered commissions and other benefits, including stock options and royalties.

Incentive compensation management software that’s right for you

95% of all sales reps say a best-in-class sales tech stack is essential to their success, yet most still use outdated, legacy commission management solutions.

CaptivateIQ  puts the control over incentive compensation back into your hands. Build customized plans and make adjustments as needed to improve outcomes and obtain better results. 

The intuitive CaptivateIQ experience puts users in control of designing, deploying, and adapting effective commission plans so that sales teams can continually meet — and exceed  goals.