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

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
• 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.

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.

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.