In my book, What Your CEO Needs to Know About Sales Compensation, I describe why thresholds are good for some sales organizations but not for others. Today, the logic still holds, but what was right for one company back then may be wrong for it today. With COVID-19 and its effects on so many industries in mind, I think this is a good time to revisit and update the topic.
As I describe in the book, a threshold is the performance level at which the compensation plan begins to pay incentive. Say a rep has a quota of selling $5 million in revenue annually. She may have a threshold of $2 million, or 40 percent of quota. If she sells less than that, she will earn her base salary but no incentive compensation. Once she reaches that threshold point, the incentives kick in and ramp up pretty dramatically to target incentive (at her $5 million quota) and above to the upside potential.
Sounds like this practice could be tough on the rep. Why even use a threshold? One reason is that the company already pays a base salary for the core job responsibilities and minimal performance, so paying incentive on top of that would be double-paying. Another is that by using a threshold, the company sets a clear minimum performance expectation. Through the math, the message is that performing below a certain percent of quota is unacceptable. In the short-term, a rep simply wouldn’t earn any incentive. In the mid-term, if this continues, she may find herself working for a different company. A third reason for using a threshold is to fund upside incentives. Yes, what I like to call the Reverse Robin Hood Principle is in action here because the company takes the incentives that would be paid if a threshold didn’t exist and transfers them to the top performers.
Thresholds Aren’t for Everyone
For what types of jobs are thresholds appropriate? Typically, that decision is largely based on the job’s sales strategy and type of sale. But today, it may also be affected by the pandemic. In the book, I examined at a couple of factors to determine whether we might use a threshold.
The first is what we humorously call the Bus Protocol, which asks the question, “If at the beginning of the year the rep was hit by a bus, what percent of her annual quota would come in without her there?” Today, during the pandemic, the Bus Protocol could easily be the COVID Protocol. “If midway through the year, the customer’s business gets ‘hit’ by a virus, what percent of the rep’s annual quota would still come in?”
The second factor is sales type. On one end of the scale are event-driven sales. These sales are occurrences like selling a major project, a piece of equipment that’s a capital purchase, or an enterprise software installation. Event driven sales don’t repeat every month and don’t happen without significant sales organization effort. On the other end of the scale, are annuity sales. These are sales that have a high degree of recurrence. They may be services or consumables that are used predictably or even under an agreement or contract. Of course in the age of COVID-19, both event-driven and annuity sales could be thrown off for a quarter or two, a year, or even indefinitely. You know your business and you know your industry. There may be geographic issues affecting sales; or if you sell certain types of medical supplies, sales may be gangbusters during the pandemic, but you know that when things return to “normal” so will your company’s revenues.
Taking all of that into consideration, if the job has a large base of current customers with a large portion of revenue that’s recurring and would come in without the rep, then the plan may have a significant threshold in place. By contrast, if the rep is focused on new customer selling or working with current customers that have little recurring revenue or make major event-based purchases, then each new sale may simply not exist without the rep. To reward for each sale that comes in with a high degree of rep influence, the plan may have little or no threshold.
This is a great tool to cut through the arguments about thresholds with some straight logic and cross-industry practices. The actual level of the threshold, in terms of percent of quota, is usually set either mathematically or through management expertise. Using the mathematical approach, the organization should look at quota attainment historically at the 10th percentile, and use that as an estimate of a reasonable threshold. The management expertise approach answers the question, “Below what point would it simply not be acceptable to pay incentives?” Most executives will have an immediate answer to this question and most, if asked separately, will come within 10 percentage points of one another. It’s sometimes effective to combine the mathematical approach and the management expertise approach to arrive at a number.
Once the threshold point is set, beware of changing it from year to year unless there is a significant change in the business or environment, such as COVID. In this case, the performance distributions are changing during COVID with fewer reps reaching goal and threshold points shifting down. Further, many companies are lowering or eliminating thresholds during COVID to help reps get in the money sooner and ease cash flow concerns. Lowering or removing thresholds is, in effect, a pay advance or draw for reps that you anticipate will exceed the old threshold. It does carry a cost to the company for reps who fall below the old threshold.
Before changing thresholds, or making any compensation plan change, think through the bigger objectives for your business and the real problem you’re trying to solve. This problem-solving approach, we use regularly at SalesGlobe, will often lead you to a different and better answer than just addressing a specific plan mechanic like thresholds right off. While changing a threshold level, or any other plan component, too frequently risks communicating confusing messages to the sales organization, during these unprecedented times, organizations may want to rethink thresholds—not permanently, but just until business returns to normal.
For more thoughts about thresholds and other incentive compensation considerations, watch this recent SalesGlobe webinar about sales compensation in the age of COVID-19.