The Sales Learning Curve Part III: Compensation for Early Stage Startups
Tactical takeaways for paying people
One of the most frequent questions founders ask me is about the structure of sales compensation. How much of the pay should be base, and how much should come from commission? And how in the world can a company estimate what target sales volume should look like for those commissions?
Most folks get this very, very wrong.
Our current stop on the journey
This is the third installment in my Sales Learning Curve series, based on the article1 of the same name from Harvard Business Review. In Part I, I introduced the Sales Learning Curve and the why it creates an entirely different strategic landscape for startups when it comes to managing sales. The tactics I discuss in today’s piece are entirely premised on Part I. If you are not familiar with the core elements of the learning curve, you’ll want to read it. Otherwise, my advice might seem nuts.
In Part II, I turned to the first set of practical implications, namely the limited return on too much sales hiring, the central role that organizational learning plays in your sales efforts, and the almost certain negative financial return on sales staff.
Today we turn to compensation and quota.
What to do about the guessing game of quotas and commissions
Really. Just get rid of them. They are stupid. It’s not a good idea to be stupid.
See how easy that was?
If you want me to spell out the logic, I can, though I hope, dear reader, it is obvious by now. This reasoning rests on the premise of the curve’s characteristics. It is virtually impossible for an early stage startup to grasp ex-ante what solid performance looks like, because the company is too early in its organizational learning journey. People show me they know this implicitly when I get the “how the hell am I supposed to know what quota should be?” question.
Even in the rarest of rare case where you compete in a market you know super well, and you know all the quota details for your competitors, and your product and business model is highly comparable,2 that still won’t give you a clear view into what performance looks like in a nonmature company. So instead of pretending to be able to fumble through this fog of confusion, it’s better to work from the simple, authentic understanding that you don’t know. It’s very freeing to own it.
Getting this wrong is a big deal, by the way. You are almost certain to aim high or aim low, and the right targets will change in sudden spurts as your product and pitch evolve, so you may very well end up way too high sometimes and way too low at others.
If you aim too high, you will pay a dear price. You will deter good salespeople from joining. You will demoralize the ones that are there. You might fire them, or they will quit in shame, or out of frustration that they aren’t hitting targets and getting commissions when they know they are good. You may even prevent young, highly talented salespeople, who haven’t yet gained confidence, from sticking to a promising professional field. And all this frustration and demoralization and turnover will kneecap the environment you need to maximizes your sales team’s ability to drive organizational learning, which is the surest and fastest path to more revenue, as I noted in Part II. Basically, it will make you much more likely to fail.
Leslie and Holloway say something similar. Keep in mind that their audience is mostly executives in mature organizations launching new products or going into new markets, which means they are probably a fair bit farther along their learning curve than you are. Still, even for these readers, the authors say that “It’s both unrealistic and potentially dysfunctional to assign large sales quotas in the initiation phase . . . A heavily commission-based pay plan is not only unlikely to achieve sales objectives but can inhibit learning.”3 All the more for you, startup entrepreneur.
If you aim too low, it can also be detrimental. Sure, your salespeople will love their lives for a hot minute, because they will be making lots of easy money. But that is almost certainly money you don’t have, and if you do have it, you should be spending it on something other than freebies for salespeople who aren’t really earning it. Keep in mind the insight from Part II that you will almost certainly lose money on these folks to begin with. So overpayment would turn that into a galling waste of resources. A “windfall” for your salespeople is also a great way to make investors and board members angry.
Too small a quota and high commissions can also hurt learning, although probably not as critically as too high a quota and small commission. If the target too low, it mostly will look like things are going so good that the impulse to improve your messaging and product will ebb. And, just like too high a commission, your salespeople will be thinking 100% about money, and not about driving learning. That may seem normal for a salesperson, but it isn’t actually the right focus in the initiation phase of the learning curve. (In Part IV, I address the personality profile you need to hire for this stage). They won’t be focused on how to debrief and improve the product, and they won’t be sharing insights that might help you realize their quotas are too low. You’ll starve yourself of important information.
Finally, whether because of investor pressure, or your own realization that you’ve screwed up, if you do start to realize you’ve made it too easy for them to mint money, you’ll have to adjust. Even if you warn salespeople that might happen, any significant reductions in their commissions will cost you dearly in terms of people, morale, and organizational learning.
So, damned if you aim too high, damned if you aim too low. And you are likely to do at least one of these.
The incessant objections
I’ve explained this to founders and most of them sigh in relief.
But a few don’t. Their persistent worries tend to come in the form of two objections
The most common concern is that salespeople need a significant quota and commission to be motivated. But this is mistaken. First, it’s offensive. We salespeople are a bit of a different breed, but we are not BF Skinner’s rats, thanks. This is especially true of “renaissance reps,” the personality profile you need to hire for this stage. (More on that in Part IV). The discussion above also makes clear how demoralizing your almost-certainly-very-wrong targets will be. Overshoot on the quota and you demoralize the rep because he can’t reach. Or undershoot and you temporarily overpay the rep, and then eventually take away the windfall, demoralizing him.
Also, the Reaganite idea that a super low base will somehow motivate these reps is also confused. If you put someone in a state of scarcity and pair this with a high level of uncertainty about what level of performance is even reasonable, you are much more likely to make them anxious and undercut their performance.
In a similar vein, some people argue that good reps will be attracted to commission based plans and weak professionals will be repelled. The idea is that a good salesperson will have the confidence that he can deliver on a mostly-commission based plan. A bad salesperson will be afraid of this kind of commission structure and run the other way. The hope is to let self-selection do the work.
While this might work in a more mature market and company, it’s completely wrong for startups and misses the point about the sales learning curve. I’m a very confident salesman. I know lots of other ones too. Let me clue you in to how we think. We think we can get good jobs. We don’t think crappy pay structures are compelling. If someone offers me a low-base, high commission job when there is no clear comps for what success looks like, I usually think something like “wow, no thanks.4”
Don’t be a shark; salespeople aren’t there to take on the risks that are yours as an entrepreneur. They don’t get nearly enough stock to make it worth it. The lid on a good salesperson’s performance at this stage has much more to do with your organizational learning curve than it does the rep anyway. Good professionals will see this and have nothing to do with you if you try to convince them they should shoulder responsibility for the fact that your company isn’t ready for prime time yet. You’ll either be stuck with the lowest tier talent, or will at least have to rely on unethically bamboozling them.
A better way
What, then, should you do? It depends on a number of specifics, but there are some useful tactics that can guide you through these.
A rep’s base should be equal to 80%+ of his on-target earnings, based on your comparative market salary analysis
Any remaining gap between the base and targeted annual earnings should be filled with a bonus, not a commission.
A bonus is earned in one of two ways: quantitative inputs, like calls made by an SDR, or qualitative outputs like contributions to learning cycles from a senior rep. If you think you cannot judge a person’s performance based on qualitative outputs, fire everybody and give your money back to the VCs.
If you cannot shake your (intransigent, incorrect) sense that a traditional commission is the only way to motivate a good salesperson, feel free to offer one. But make it all upside. You can tie it to crossing some revenue threshold and then offer a percentage of incremental revenue. But it needs to be clear that you have zero expectation that anyone crosses that revenue mark, since you don’t know what good performance is yet. And then don’t bring it up anymore.
Better yet, if you want your reps to be motivated by sharing in the upside of their good work, offer them stock options instead.
The Sales Learning Curve, Mark Leslie and Charles Holloway, Harvard Business Review, Jul.-Aug., 2006.
This sounds much more like a commodity than a startup, by the way. You may have other issues to worry about!
The Sales Learning Curve, Mark Leslie and Charles Holloway, Harvard Business Review, Jul.-Aug., 2006.
Technically, the words that come to mind in such situations aren’t fit for polite publication.