The Basics of Sales Compensation: Base, Commission, and Target
Sales compensation = base + bonus
Is the above statement true?
I was asked to confirm the statement recently when talking about sales compensation vs non sales compensation in a company (“why are sales people paid so much!?). I wondered if there was a simple way to explain sales compensation, especially to non sales team members. Here’s my stab at a high level explanation.
The sale compensation formula above is false, and should be —
Sales compensation = base + variable compensation
This article is a 101 on how sales compensation broadly works. It is not a deep dive into sales compensation calculations or a discussion on target setting.
Key definitions
OTE, target, quota, base, variable/commission — here’s what these terms mean:
- OTE: On Target Earnings refers to a salesperson’s compensation if they reach 100% of their quota.
- Quota: A sales target set over time period (monthly, quarterly etc) that a sales person must reach to get OTE. This quota comes from finance and is divided across teams, sales managers, and account executives.
- Target: The overall quota that a team or individual has to achieve.
- Base pay: Guaranteed pay, no matter how poorly (or well) someone performs.
- Variable pay/Commission: How much compensation a salesperson receives based on their achievement against a target.
How to calculate sales compensation
The formula and how the math works
The general formula is OTE = base + variable [1]
Variable/commission is based on performance against quota. A more detailed formula is OTE = base + % performance against target*variable pay. In the example table below:
- Base pay is 60K (for simplicity). The company is generous and so 60% of OTE is base pay, and 40% is variable.
- If a sales person hits their quota at 100%, they’ll get the OTE of 100K
- If sales person hits 20% of quota, they get 20% of the variable pay, which is 20%*40K=8K. So total take home is 60+8 = 68K.
Levers affecting OTE
- Split between base and variable pay: 60–40 is one option, but in some companies that could be 50–50, or 20–80, which changes sales behaviour. The split depends on what kind of sales behavior leadership wants to encourage. A plan with a higher variable component will likely drive more aggressive behavior.
- Achievability of targets: A company sets benchmark for what percent of salespeople should make their goals (typically 60%–75% only: source). If OTEs are woefully unachievable, salespeople might give up.
Final observations
- People are persistently optimistic that they will hit 100% or more of their target, and capture their entire OTE. No doubt some people will, but not everyone [2].
- Revenue per sales person should be 5–7X their OTE. Back of envelope, if a sales person’s OTE is ~300K, they should be bringing in at least ~1.5M of revenue.
- Better understand how sales teams work by understanding their compensation. Incentives drive behavior and understanding how compensation works helps non sales teams understand sales and how to better work together.
[1] Note: I’ve ignored accelerators/kickers when people hit more than 100%. Those accelerators and kickers significantly increase take home earnings, but widely by company. I have left out total compensation (PTO, insurance, other benefits). Recommend following @Corporate.bro on insta for more up to date information on total sales OTE across companies.
[2] If everyone’s hitting targets, the targets are likely too low and management/finance will have to raise them.
