There are two camps on this question. Many sales VP's look at the compensation budget for sales people and try to build a model that will keep sales salaries within a range that is competitive with the marketplace but at the same time is not disproportionate with what they expect the job should earn. An opposing philosophy is to track cost of sales but not worry much about management of total dollars. Focus instead on contribution ratio to revenue. This is most easily described as total compensation for a rep should be x% of the total revenue that said rep brings to the organization. Thus if a rep brings one million dollars to the table his cost should be some fixed percentage (ie. base +commissions).

In my mind trying to manage cost of sales as a finite number is self defeating as karmic managers. It is clear that gross margin must be watched and you definitely dont want to pay significantly more than what is competitive in your space but these figures fail to take into account the relative nature of individual success to corporate success. The purpose of the compensation plan is to incent the sales people to exceed the targets placed before them. Managing cost of sales as a fixed figure will create diminishing returns as reps exceed their quotas in a couple of ways.

1. Management is forced to reset quota on a monthly/quarterly basis for reps that over perform. Effectively slapping them for doing exactly what they were asked to-namely exceed their number.

2. Institute compensation caps or windfall clauses where reps are capped at a maximum earning potential in the year. Probably the single most de-motivating thing sales management can do to sales people.

So how do you ensure that sales compensation is not grossly out of whack with what the industry is paying? The key factor is it is managements responsibility to do their homework. Understand the pipeline, what is possible for reps in aggregate to achieve in the period, what is a stretch target, and how is your salesforce segmented. It is sales management's responsibility to build a performance plan tied to compensation that strives to achieve a budgetary figure and is tightly tied to contribution ratio, This way if reps are blowing out your compensation budget you are assured that your revenue targets have correspondingly being blown away, which makes the difficult conversation with your CFO that much easier.

By focusing on the ratio of compensation to revenue as opposed to simply fixed dollars you will stay clear of some of the classic errors made by sales organizations that inevitably result in high turn over and under achievement.

Moment of Zen
All things appear and disappear because of the concurrence of causes and conditions. Nothing ever exists entirely alone; everything is in relation to everything else. -Buddha

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