Want to start a spirited debate about sales compensation? We’ve seen that Finance and Sales often have differing opinions on sales comp. A particularly thorny area is if and when incentive comp should be capped. For example, a recent client outreach went something like this:
“We have caps in our plan. Our sales leaders are complaining that it demotivates the team. Finance is worried about how we manage our cost of sales. What’s your take on caps on incentive comp? Please share considerations and best practices.”
Asking whether the plan should be capped is a surefire way to take attention from any other undesirable topic. A cap is an upper limit on inventive earnings in the sales compensation plan. Using a cap creates actual or perceived limitations on upside earnings while mitigating risk for the company.
While, at SalesGlobe, we don’t recommend caps (largely for motivation reasons) there are some legitimate reasons why a company might employ them. These include protecting against unpredictable payouts resulting from major deals or bluebirds beyond the rep’s control, poorly set quotas, unreliable financial modeling, or production-constrained environments where demand may outpace supply or the company’s ability to maintain quality levels.
Like many facets of sales compensation, caps are less about the math and more about the people, behaviors, and psychology. The mere existence of a cap can create concern among reps that’s disproportionately larger than the reality. We frequently interview sales organizations and ask reps about caps on the plan. We’ll hear something like, “One of the things I dislike about the plan is that it’s capped.” We’ll then ask if they’ve ever actually hit the pay cap. “Well no . . . but there was this person two years ago that did, and she should’ve made a boatload for the deals she brought in that year.”
Methods of Capping or Governing Payouts
SalesGlobe recently conducted a study on sales compensation practices with WorldatWork that included an examination of methods of governing compensation payouts*. Among companies that span a range of industries, 56% use at least one of the following methods:
- Caps, used by 35% of companies, set an absolute limit on incentive earnings. The use of caps was more frequently cited by companies with greater than 1,000 employees. Caps are used in a few ways:
- Caps on total incentive compensation. These set a limit on incentive earnings, usually as a percent of quota attainment or a percent of target incentive. For example, the company may cap incentive pay at 300% of target incentive for the pay period or the year. The risk of using this approach is that it may motivate reps to game the plan at the endpoints of each time period (e.g., month, quarter, or year) by holding off on new sales until the beginning of the next period when they will receive additional incentive pay.
- Caps on deals. These set a limit on incentive earnings at the deal level, typically at a single deal size (compensation is capped on deals larger than $x) or alternatively a goal attainment amount (compensation is capped on deals that represent x% of the rep’s total quota). The risks are the same as the total incentive cap (slowing down early and pushing deals to the next measurement period) in addition to motivating reps to split deals into smaller parts or to space deals out over time.
- Caps on products. These set a limit on incentive earnings at the product level, usually based on volume or dollar amount. Product caps may be used to pace sales with production capacity or to prevent reps from overweighting certain products in their portfolio relative to other products. Product caps may be used on total product sales or on product sales at the customer level. The risks of product caps include preventing the rep from fulfilling customer needs, deal splitting, and pushing deals into subsequent measurement periods.
- Regressive rates or decelerators, used by 30% of companies, gradually reduce the incremental incentive payout for each percent of quota attainment above a certain level (e.g., 300% of quota). This approach has the effect of decreasing the slope of the payout curve while still continuing to pay additional incremental dollars for higher levels of achievement. While the rep can still continue to earn incentive above the regressive rate point, it can slow down extreme levels of incentive payments.
- Blue bird or mega deal policies, used by 28% of companies, limit extreme incentive payouts, usually at the deal level. These policies can isolate deals above a certain dollar level or above a certain portion of the rep’s overall quota and treat them in several ways. Pay treatment may include removing the deal from the core sales compensation plan and paying a separate commission rate, or reviewing the deal to determine the appropriate level of incentive compensation. Often, the objective of the blue bird or mega deal policy is to isolate the deal so that it doesn’t dilute the core incentive plan (one deal exceeding the rep’s annual quota and motivating them to go on autopilot for the rest of the year) and to align compensation with the rep’s actual level of influence or involvement in the sale.
For the company, the benefits of using a cap may be minor compared to the potentially negative message it sends to the sales organization. There are alternatives to a cap that can still limit risk while allowing you to communicate a positive and inspirational message about unlimited earnings opportunity. These include:
- Effective modeling to know exactly what could happen under a range of performance scenarios. These may include a normal distribution of performance as well as random distributions and situations where a majority of reps exceed expectations. By looking at the range of possibilities, the organization can pressure-test the plan and know the likely cost of sales under any situation.
- Policy approaches that may include management review of incentive payments above a certain percentage of target incentive. This allows the organization to make sure the rep had significant influence over the sale rather than being the beneficiary of a liberal crediting policy and being paid for “touch revenue” actually sold by his teammates.
Uncapping the plan can be motivational for top performers as it creates a perception, and often a reality, of unlimited earning opportunity. Avoiding caps requires good historical data, market opportunity data, and financial modeling. An uncapped plan must also be consistent with the sales culture of the organization, especially if in some cases reps can earn more than their managers or senior sales leaders. Test the options with your plan in the context of your sales culture to determine the right approach for your organization.
*SalesGlobe and WorldatWork Sales Compensation Programs & Practices Survey that included 317 companies, conducted June 2020.
Read more about incentive compensation in What Your CEO Needs to Know About Sales Compensation by Mark Donnolo.