Sunday, October 9, 2011

Sales Commission Out of Control -- Do You Cap It?

A manager posted a question on a CEO web forum about the idea of capping sales commissions:  "One of our sales reps is blowing out his sales numbers - and is set to earn commissions that far exceed any other rep and even place his total comp above any employee, including myself. I want to understand if it is ever wise to put a cap on commissions when we revisit comp plans for next year?"  

When is it a good idea to put a cap on the amount of commission someone earns? Resounding answer: NEVER. If you ever get these inclinations, take a cold shower and rethink.  Rationales for this conclusion ranged:
  • That's a good way to demonstrate to someone that you can't be trusted -- set up a compensation plan, then when the person starts doing what you said you'd reward, renege on the bargain
  • f you created a defective incentive compensation plan -- one that pays too much money for too little accomplishment, it's your fault, not his
  • If your plan is well designed and you have a guy hitting it out of the park, what's the problem? Pay him what you promised and hope he'll just keep on doing it more.  If a star salesman's economic value is higher than yours, his manager, get over it. 
The prime objective (and litmus test) of a compensation plan is "The House Wins" -- hopefully by a factor of 4:1 or so. What do I mean by that? This is a good application for analysis at the margin. What's the marginal benefit to the organization (gross margin) of the next $100 of sales (or $100,000)? And what's the salesman's cut of that? Regardless of how the commission is calculated (on total revenue, on gross margin, on units sold, etc) you'd like the house to have a "win" of at least 4:1. That would mean a sales commission of 20% (or less) of gross margin. Of $100 gross margin, salesman gets $20 and house gets $80 -- a 4:1 ratio.   3:1 isn't bad, either -- 25% of GM for the salesman. 

What if there's a base salary involved? Is the commission rate the same? Perhaps, but you don't want to be paying commission on the first dollar of sales. See: "The #1 Incentive Compensation Plan Design Mistake". There's another variation on that theme at: "Incentive Compensation Not Working?  Try Plan "B".

Are you completely unhappy with your incentive compensation plan? You're not alone. See: "8 Questions to Ask if Your Incentive Comp Plan Isn't Working".

PS:  One misguided respondent commented that "Perhaps you could buy off the salesman with equity in lieu of commission".  If you ever start thinking about giving away equity, take a cold shower, slit your throat, then call me.

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Terry Weaver

Chief Executive Boards International

Chief Executive Boards International: Freedom for business owners & CEOs -- Less Work, More Money, More Freedom to enjoy it 


  1. There were a number of useful comments on this topic on the ExpertCEO web site. One comment dealt with "special situations" where a large sale was made but there were extra-ordinary expenses or custom product development efforts associated with that sale. In these circumstances you need a "special situations" clause in the commission plan to take this type of situation under consideration. While not a cap per se, it does result in the reduction of "commissions".

    Many companies, especially VC-funded, high tech companies, offer commissions that include some type of equity in lieu of cash. It can be highly motivational and serve to conserve cash which is needed for investment in development activities.

    There are no absolutes (i.e. NEVER) when dealing with sales commissions.

    For the full discussion thread, take a look at

  2. Capping a salesperson's commission is a sure way to lose your top salespeople. I have worked for two very large, very well-established industry titans that built their entire empires on the success of highly compensated salespeople. The comp plans were fair, and as the salesmen made money, the company made money. Customers were happy, because the salesmen could only sell to happy customers.

    Each company changed its comp models, capping the the sales incomes and making it far harder to achieve an income within 75% of the average from previous years even with comparable results.

    Both companies have seen a mass exodus of their salesmen, and consequently, those companies' market shares and sales numbers have dropped dramatically. These "rain makers" of course left for new companies, or started their own, and they are profiting nicely at a significant cost to their previous employers. Morale at the old companies is much lower, as the replacement salesmen are of much lower caliber and professionalism.

    If you don't like your comp plan because it is not in line with your growth and margin strategies, then change it to line up with your business goals. But if you don't like it because your top salespeople are occasionally adding more value than the "C-Suite", then be prepared to work that much harder to sell your company.


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