~ Check out our continuing series on Sales & Finance issues with Randy Bolten*, former Controller with Oracle & CFO at Broadvision, if we can help you with business issues that deal with the Sales team, let us know at comp@121siliconvalley.com~

A Comp Plans Last Mile: The PowerPoint Presentation - January 4, 2012

Happy New Year! Over the last few weeks, weve talked about the hard work needed to implement an effective incentive compensation plan. We reviewed the spreadsheets to make the numbers meaningful, and the documents that put the plan into plain English. All that remains is the most important task the presentation to the sales force. The presentation should be only 8-10 slides and should accomplish two thing: (1) EXPLAIN, and (2) SELL.

1. EXPLAIN. Never assume you audience has read all that stuff you sent them. This is your chance to make sure everyone understands at least managements key initiatives:

• The basic logic underlying the plan

• How the plan relates to the companys central strategy and objectives

• The extent to which underachievement is penalized and, more important, over-achievement rewarded

• How the plan will be administered and payments made

A walk-through of the basic calculations, and examples of three or four scenarios, will really assure the target messages are received.

2. SELL. After stock options, incentive comp plans are by far the most expensive benefit most companies, especially high-tech high-growth ones, offer. For that kind of money, they need to be powerfully effective. So a powerful presentation should be one of the centerpieces of the sales teams annual kickoff meeting. Without overselling the plans potential (or at least not by too much), this presentation should:

• Get the sales force charged up

• Reiterate the companys vision and mission

• Tell the sales force that they are an essential and respected part of the enterprise

That last point makes it essential that the presenter should be as senior as possible. Ideally, the CFO or the worldwide sales VP, even the CEO should be standing up there. At the very least, the presenter should be senior to all the comp plan participants in the audience. Having some analysts and bean-counters in the room to explain the details is fine, but as the main presenters they send the wrong message.

This discussion illustrates the 80/20, in spades. Maybe even the 90/10 rule. Creating and giving an effective presentation is a tiny fraction of the effort involved in implementing comp plans, but it makes all the difference in how effective those plans are in contributing to your companys success.

Comp Plans That Work "The Other Documents" - December 20, 2011

In my last post, we reviewed the document that is the cornerstone of every well-run plan the commission spreadsheet. In this post, well discuss the other two pieces of documentation that are critical to plans that truly motivate:

1. The English-language description a short description of the logic behind the plan
2. The legal document in essence, a contract between the sales rep and the company

The English-language description is a cogent, clear description of how the plan works and the logic underlying it, in plain English. Together with the spreadsheet, it provides a complete description of the plan. Some of the elements this description should include are:

• High-level objectives a few sentences on the management and motivational principles underlying the plans design. For example:
  • Does that company have product mix objectives?
  • Does the company place a value on bringing business in sooner than quota?
  • If the plan calls for accelerated commission rates for over-quota performance, why has the company chosen to do that? (Such plans can get expensive.)
• Key terms definitions and clarification of important terms and language. For example:
  • When are commissions earned?
    
  • GAAP revenue recognition? Booking? Collection? Something else?
  • When are commissions paid? When earned? Upon collection? Something else? A combination of the foregoing?
• The math an English-language description of how the spreadsheet formulas actually work.

A properly written description should rarely take more than two or three pages. I might also add that this is a business document, not an employee relations document this document should be drafted by people in finance and sales, and not by HR staff unless they are highly knowledgeable about incentive comp.

The legal document is a good idea considering the large amounts of money changing hands (God willing!). It should be signed by both the sales person and a senior officer of the company the more senior the officer, the stronger the message of respect for the sales person and importance of the comp plan. In most well run companies, sales reps cant receive commission payments until the signed document is on file. Some of the elements in this document should include:

• A clear reference to the plan parameters that is, the spreadsheet and the English-language description Ive just described. A simple, efficient approach is to include these documents as attachments to the legal document.
• A clear reference to the companys policies and practices, such as its revenue recognition policy and it corporate conduct policy. Some agreements require the sales person to acknowledge that he or she has received and read these policies and practices. Some also explicitly state that violating the revenue recognition policy and some other policies may be grounds for non-payment of commissions and other disciplinary action.
• The policy regarding splitting commissions.
• The policy regarding business if the sales reps employment has terminated, or if the sales rep has been promoted or no longer covers the territory for other reasons.
• The process for addressing compensation disputes or requests for exceptions to the plan.

I dont feel strongly about the length of this document, because ideally it wont see day-to-day use. However, it doesnt need to be a legal textbook, either. For example, laying out the procedures for every possible permutation of employee termination or territory change and Ive seen contracts that droned on for several pages on this subject doesnt serve much purpose. In real life the most complex situations of this type are usually resolved by negotiation and not by the exact words of the contract.

Drafting these two documents is the least fascinating part of the process of creating effective compensation plans. But if you do them right, not only will you have a coherent, manageable plan, but youll save an enormous amount of time and trouble when things get complicated.

Comp Sales Comp Plans That Work The Spreadsheet - October 20

In my last post, I listed two critical tasks for delivering an effective sales compensation plan. The first of these is easy-to-understand, meaningful spreadsheets and other documentation. In this post well discuss the central document of any plan the spreadsheet. Heres an example spreadsheet; the important elements are circled in red and identified by number, with discussion of each major area following:

(1) Identification and Personalization. At the risk stating of the obvious, a commission spreadsheet should always identify the company, the year, and the plan. Moreover, every person participating in the plan should have his or her own personalized spreadsheet even if every rep has the identical compensation structure, personalizing each persons plan is a gesture of respect. Note that all cells containing custom information are shaded in gray.

(2) All specific plan parameters. A well-designed plan should prominently specify all computation details. In this example, these are (a) the fact that the compensation basis is reported revenues, not bookings or collections, (b) the reps quota, and (c) the commission rates applicable at different levels of production. [Note that this example is of an accelerated plan, meaning that the commission rate increases with higher levels of achievement.]

(3) Scenario analysis. The first thing that most sales reps will want to know is their earning potential, and especially how much they will earn in the event of significant under- or overachievement. Including percentages of quota and of target compensation along with the raw dollar amounts helps provide context. In the above case, there is a modest penalty for underachievement commissions at 75% of quota are only 71% target commissions but overachievement is heavily rewarded. For example, a rep producing $4,000,000 in revenue or double the quota earns $330,500 in commissions, or 275% of target commissions much more than double the target.

(4) What-If. All sales reps want to know where they stand. Giving them a tool to figure that out easily without having to check in with the commission gurus in the bowels of the accounting department can help make the commission plan the motivational tool its always intended to be. You want sales reps to go through thought processes like, If I work this weekend instead of going camping, I might be able to increase the size of the deal by $45,000. I wonder how much more Ill earn if I do that. . . ? Or, How much do I need to sell to enable me to afford that Porsche?

In my next post, well move from the numbers part of the plan documentation to the words part.

VP Sales AdvisoryNote - September 28

Delivering Sales Comp Plans That Actually Work

For companies with December 31 fiscal (and comp plan) years, its time to start thinking about next years incentive compensation plans. For September 30 companies that havent gotten to that task yet, its really time to get started!

This is a lot of work, to be sure, but its critically important for high-growth companies to get their incentive plans just right. A lot of people think the challenging tasks are:

(a) setting the target compensation amounts for all the participants, and

(b) developing the compensation algorithms.

If youve accomplished those two tasks, youll have an effective, successful compensation scheme, right? WRONG! Not only are they the easy part of the whole effort, but even when you do a great job on them, if you stop there, all that hard work will have no value to your company.

There are two really important tasks that a lot of companies just never get quite right. For incentive compensation to be successful, you also have to deliver:

• Easy-to-understand, meaningful spreadsheets and other documentation.

Designing a great comp plan only has value if the sales force knows how it works and why it works.

• A live, in-person presentation by senior management.

Its essential that the sales force see that the comp plan is an important element of the companys strategy, and that senior management was involved in the process and buys in.These tasks are time-consuming and unglamorous, especially the first time or two around, but well worth the trouble. In the next two posts, Ill talk about each of these tasks in more detail.

And,,,,one more piece of advice: No matter when you get your comp plans done, never, ever, ever announce them to the sales force until after the current fiscal year has ended.

The last thing you want is a smart salesperson and the good ones are always smart! figuring out that he or she can make more money by letting a big deal slip over into the next year. That cant happen if the sales force doesnt know what next years plan is going to be.

VP Sales Advisory Note - April 1

Using a Value Calculator to Sell Your Products Part II

Inour last post, we introduced the idea of a value calculator as a powerful sales tool. To refresh your memory: The XYZ Software Company sells an add-in solution for an enterprises ERP system, to address situations when a single order has to be fulfilled in multiple shipments. When that happens, the enterprises own end customers question the invoice, causing the enterprise to have to devote man-hours to documenting and supporting a perfectly valid receivable, and delaying collections. XYZs ERP add-in can help solve this problem. To help prospects understand the XYZ Software value proposition, XYZ developed a Value Calculator, and the one theyve prepared for the Levi Lauren Outerware Corporation (LLOC) is shown below:

The important design characteristics of a model like this include:

1. Inputs and outputs are separate from each other and visually easy to distinguish:

1. Global inputs about the prospects business in general are at the left, and the inputs specifically related to the problem XYZ Software solves are in the middle column.

1. Inputs required to describe the prospects current situation are shaded in yellow, and the input values that will be improved by the XYZ Software solution are shaded in pink.

1. The outputs of the model are at the right, and further distinguished by being in blue type.

1. The inputs are understandable and easy to obtain, either from publicly available information or from ordinary sales legwork.

1. The outputs are obviously meaningful to the prospect. What prospects CFO (or other senior executive) wouldnt grasp the value of a 21-day DSO improvement, or over 10,000 man-hours saved?

1. The ultimate value is not only boiled down to a single number Total Savings ($/yr.) but is easy to find and in larger boldface type.

1. Key indicators and intermediate values add context. Calculated values like Pretax Margin, No. of Xactions Affected, Revenues Affected, and Man-Hrs. Saved put raw numbers in perspective and help the audience see how the ultimate values were calculated.

1. The model has the right amount of customization: this general model obviously applies to a very wide range of prospects, but there is also enough information related specifically to the target prospect to make it relevant to them alone. The prospect can see the value calculator as part of a sales effort personalized for them.

1. The model is easy to modify, even in real-time. If someone at the prospect company questions an input assumption, just drop in the number he or she suggests. The odds are good that buying XYZ Softwares solution will still look like a good decision, and the prospect will appreciate your openness, flexibility, and agile thinking.

1. The whole thing fits on one page! A more complicated model, or one that had to look good in a PowerPoint presentation, might need two pages maybe! but you get the picture.

In order for a model like this to do its job as a sales tool, it needs to properly support your value proposition. But more than that, it needs to do that in a way that uses numbers and terminology meaningful to the prospect, and is easy for the audience to understand from a quick glance. In other words, as in any other element of the sales process: Looks matter, and first impressions matter.

VP Sales Advisory Note - December 9

Using a Value Calculator to Sell Your Products Part I

We all understand how critical your finance team can be in helping you negotiate and close your deals, but they can often be a huge help even earlier in the sales process itself, by helping you make the best possible presentation of your products value proposition.

Consider the example below the XYZ Software Company sells an add-in solution for an enterprises ERP system, to address situations when a single order has to be fulfilled in multiple shipments. When that happens, the enterprises own end customers question the invoice, causing the enterprise to have to devote man-hours to documenting and supporting a perfectly valid receivable, and delaying collections. XYZs ERP add-in can help solve this problem.

This is the kind of problem where its easy to quantify the financial benefits, so the XYZ sales force has worked with the finance team to develop a powerful, concise, and clear value calculator, which can be delivered to prospects in a short handout, or dropped right into a PowerPoint presentation. Heres what it looks like for one particular prospect, the Levi Lauren Outerware Corporation (LLOC):

The left-hand column provides a summary of the prospects overall business, and the middle column recaps the information specific to the problem that XYZ Software addresses. In particular for LLOC, the problem orders requiring multiple shipments to fulfill afflicts 22% of their sales transactions. The XYZ solution will reduce LLOCs staff effort from an average of 3.30 to 2.20 man-hours for each of these transactions, and will shorten average collection time from 54 days to 33 days. The right-hand column recaps the financial benefits for LLOC, and shows that the XYZ Software solution can provide a hard-dollar profit improvement of $1.3MM per year!

The value calculator has a number of powerful sales characteristics:

1. XYZ Softwares value proposition is presented clearly and in real dollars.

1. The value proposition is presented in terms meaningful to senior management, and in particular to a CFO, who is very likely to be a key player in the buying decision.

1. The presentation of the model shows that the XYZ sales force considered and researched LLOCs particular issues and needs.

Its rare for people in the sales team to have either the spreadsheet skill or the time available to deliver a clean, effective value proposition model. Thats especially true when the quantifiable benefits are a little less obvious or harder to characterize than they are in this example. But people in the finance and accounting area will have those skills, and will almost always be delighted to be asked to help in the sales process. A model like this especially if it can be standardized for the entire sales force can be a powerful weapon in your sales collateral arsenal.

In my next post well go into more detail about the design characteristics that will make a value calculator like this especially effective.

VP Sales Advisory Note -September 15

- Sales Compensation Under SaaS And All Those Other Weird Animals -

In high-tech companies, and especially in the software industry, business models are becoming increasingly varied and exotic. Thats especially true in enterprises focused on cloud computing and software-as-a-service (SaaS). Moreover, whether you like it or not, the GAAP rules for revenue accounting are becoming increasingly divorced from the underlying economic reality of the business transactions. In this new world, how should you compensate your sales force? Heres how:

Sales compensation should reward focusing on priorities consistent with the companys overall interests. Sales people should get paid in full when theyve accomplished everything youve asked them to accomplish.

Sounds simple, doesnt it? Its not, of course, but clearly understanding the meaning of these two statements for your company will make the difference between an enterprise where the sales force is on the same page as its owners, and an AIG (or any of those other companies that paid huge bonuses to sales forces while they were tanking their companies).

Take SaaS transactions, for example. Its not unusual for these transactions to involve prepayments of many months or even years of license fees. The underlying economic reality of these SaaS deals is not so different from that of their older cousins: large up-front license fees with ratable revenue recognition. How to compensate the sales force depends on the companys objectives. Consider the following relationship characteristics (among others):

• Getting paid full price, with a minimum of discounting

• Signing the customer up for a long-term relationship

• The amount of ongoing hand-holding the customer will need from the sales force (as opposed to the technical support team)

• The importance, if any, of selling the customer additional feature or additional products over time

• The role of resellers or third-party service providers in closing deals and customer satisfaction

• The role you want, or need, your sales reps to have in the collection process

You should first come to understand the relative importance of these factors at your company, and the tradeoffs among them, and then design an effective sales comp plan. These factors will determine commission plan and payment choices like:

• Commissions earned up-front vs. over time

• Commissions earned on booking vs. invoicing vs. revenue recognition

• Commission rates for product (or license) sales vs. maintenance (if any) vs. consulting vs. other services (e.g., training)

• Overlay compensation for channels reps

• Commissions earned vs. commissions paid

• The impact of A/R collections on commission payments

In my last post, I discussed the role that revenue recognition, and the revenue recognition process, had on comp plan design. My central point was that every company is different, and there can be no hard and fast rules. Its no different in this world of new and unusual business models: There are no hard and fast rules. Common sense should prevail.

As always, effective and intelligent sales compensation is an art, not a science.

- CFO Sales Advisory May 4, 2010 -

- Avoiding Moral Hazard in Comp Plans -

When designing processes and setting goals and objectives, there is always at least some element of moral hazard. Thats why in business and any other walks of life, the players arent allowed to be the scorekeepers and vice versa , even though the great majority of us are fundamentally honest and ethical. And when its hard to keep those roles separate, as often happens in comp plans, sometimes its easier and more rational to change the scorekeeping rules (i.e., the comp plan) than it is have unreasonable expectations for employee behavior.

In high tech companies, especially software, a good example of this issue is sales compensation plans based on recognized revenue (RevRec). RevRec is an obvious choice for determining earned commissions, because it is always measured, is clearly tied to stockholder value, and is scrutinized by lots of scorekeepers, often always, if its a public company even including outside auditors. The problem is this: Accurate and credible RevRec accounting depends on honest and open communication between the sales and accounting departments. This interaction is essential answering to questions like:

• Is the customer making a binding commitment, free of contingencies?

• Do the customer signatories have the authority to make commitments?

• What further obligations, beyond simply delivering the product, do we have to this customer?

• Do we and the customer have the same understanding about what the sales documents say?

In complex deals, these questions dont always have simple yes or no answers. In the software industry in particular, the RevRec rules are often so complicated that theyre hard for anyone to understand. And sadly, its even harder to understand why those rules are fair or reasonable.

If your company is in this situation, my strong advice is: Dont put your company in a position where the salesforce regularly has to choose between earning commissions they think they honestly deserve and clear, straightforward, and perhaps even honest interactions with the accounting people. Rather than making heroic efforts to obtain and verify honest answers, youre often better off instead basing commissions earned on metrics such as bookings, purchase orders, invoiced amounts, or cash collections. This decision should depend on balancing factors including:

• Which metrics are likeliest to motivate the salesforce to act in the companys overall interests

• How complex RevRec is in your company

• How clear and meaningful each metric is to the salesforce

• Ease of accurate data collection for each metric

Its an unfortunate fact of life that in many industry sectors the RevRec rules are complicated, poorly explained, and to many observers arbitrary or even unfair. But they are the rules. You may find that you can create a win-win situation by basing commissions on something other than RevRec, freeing the salesforce to deal openly with accounting on RevRec issues without threatening their livelihoods.

CFO Sales Advisory December 14, 2009

The Case Against Captain Ahab Bonuses Spotting The Great White Whale (i know)

In most cases, I am against binary incentive compensation schemes. By this I mean any plan where achieving a single, specific milestone has a large cash payment tied to it. I call these schemes Captain Ahab bonuses, in memory of the gold doubloon the Moby Dick character nailed to the mast, to be given to the first sailor to spot the great white whale. The commonest example of these schemes is a cash bonus paid when the sales rep reaches exactly 100% of quota.

My view is controversial, because we live in a culture of setting specific, measurable goals and then striving mightily to achieve them. It seems only natural to attach great significance to achieving such goals. But binary incentive schemes are a bad idea for several reasons.

1. Not many are really motivated by them. The ideal comp plan doesnt just reward the right behavior, but motivates it in the first place. Ask yourself if a large bonus for reaching 100% of quota will actually motivate in these sales rep situations:

• The big producer, for whom achieving 100% is not the issue. Not likely this person is probably shooting for 200%, or 300%, or more.

• The sales rep whose year is in the dumper, regardless. Not likely especially late in the year, it may be more rational for this person to start next year with a clean slate, with one or two deals already in the bag.

• The sales rep already at 101% (or more) of quota. Certainly not a bonus check thats already been written wont motivate anyone to close another deal or two.

• The sales rep extremely close to quota say, 99.5% early in the year. Not likely most reps arent worried about eventually generating that extra 0.5%.

• The sales rep at 99.5%, late in the year. Hmmm. What might a rep consider doing to generate another $2,000-$3,000 in business in order to get a $20,000 bonus? The term some would use for this situation is moral hazard.

2. They use up oxygen. The commission budget is finite, and you can use all of it for straight commissions, or set some aside for the Captain Ahab bonuses. In the example below, 10 sales reps each have target incentive pay of $100,000 for achieving quota of $1 million. Scheme A below is straight commissions only, and Scheme B includes a $20,000 bonus for achieving quota:

Incentive Compensation Budget Scheme A Scheme B

Total quotas $ 10,000,000 $ 10,000,000

Commissions $ 1,000,000 $ 800,000

(average commission rate) (10.0%) (8.0%)

100% Achievement Bonus $ 0 $ 200,000

Total budgeted incentive compensation $ 1,000,000 $ 1,000,000

In both schemes, the total incentive compensation is the same if every rep is at 100% of quota. However, if you accept the premise of Point (1) above that the 100% achievement bonus does little or nothing to motivate most reps, most of the time then Scheme B has no extra motivational effect. Unfortunately, at the same time Scheme B reduces the commission rate by 20% compared to Scheme A (8% vs. 10%) and thats a difference every rep sees, every time he or she is looking at one more deal opportunity.

3. Who cares, really? The notion that individual sales reps each should achieve quota has a logical flaw: Its a great feeling to have the engine firing on all cylinders, but isnt the companys objective simply to achieve the total revenue commitment it made to its stockholders? Does it really matter which sales reps brought in that last couple of deals that got the company over the hump?

In a future post, Ill talk about situations where binary incentive schemes can make sense, and how to implement them. But most of the time, while they may look good in theory, in practice they have little or no motivational value, and dilute the impact of incentive schemes that actually do motivate.

CFO Sales Advisory November 9, 2009

Using Tropical Fish Charts to Manage Visibility

At the highest level, there are three main metrics in a sales forecasting system: (1) total pipeline, (2) expected sales in the period (usually calculated as the sum of all pipeline deals, weighted by close probability), and (3) business closed so far. For reasons that I think this audience understands, all three are critical to track, each for different reasons. Even more valuable is comparing where you are in the current quarter to where you were at the same point in the last two or three quarters.

While the information in a sales forecasting system captures critical information, virtually everything in the system is just a guess: the size of each deal, when it might close, how likely it is to close, etc. For that reason, the main value of a forecasting system is not to predict future results with scientific precision, but to help impose a uniform discipline on the sales process and to give management a sense of overall trends. This makes a sales forecasting system an ideal candidate for presenting its key information in charts, rather than tables. Heres an example, recapping the weekly progress of the above three metrics for each quarter, through week 35 of the year:

Heres how to read this chart, which I call the tropical fish chart because of the visual impression I get from it:

1. The broken lines are the total pipeline, the solid lines arethe weighted average/expected outcome, and the dotted lines are business closed quarter to-date.
2. The Q1 forecasts are in blue, Q2 in red, and Q3 in green. This companysstandard practice is to begin tracking forecast progress for each quarter at the beginning of the prior quarter.
3. There are solid vertical gridlines demarcating each quarter-end (weeks 13 and 26, so far). On the last day of the quarter (OK, in the last minute of the quarter!), the three curves for that quarter should converge at the quarters actual result, shown as a small square in that quarters color. [Note that Ive included a green square for Q3, which is the target for the quarter.]
4. Ive included a thinner, broken vertical line at the current week (week 35, or 9 weeks into Q3) and also at the same point in the two prior quarters (i.e., weeks 9 and 22).
5. In most organizations, the total pipeline curve peaks at an amount much larger than the eventual result for that quarter, and the closed business curve increases monotonically starting in the first week of that quarter. The weighted average curves behavior is harder to predict, since its driven by both the total size of the pipeline and the rate of progress toward closing deals throughout the quarter.

I like this chart because it provides an at-a-glance perspective on how sales are progressing through the quarter, and whether things are on track for achieving target results. Here are a few observations you could make from the sample chart shown above:

• The total pipeline for Q3 is light compared to where we were at the same point in the two previous quarters, especially considering that the Q3 target is significantly higher than the Q1 and Q2 results.
• The weighted average number seems to be roughly on track toward achieving the target result, in spite of the relatively smaller total pipeline perhaps this is because the fewer deals this quarter are making better progress toward eventual closing.
• Closed business is much stronger at this point in the quarter than at the same point in Q1 and Q2. This supports the argument that we are making better progress on the fewer total deals in the pipeline. [And may generate a thank-you note from the manufacturing department!]

As Ive said here and in previous posts, sales forecasting systems are not a good place to look for truth in the sense that we usually think of that word with respect to numbers. The main purpose of these systems is, after all, to predict the future, and thats always messy. But summarizing the information from the sales forecasting system in a coherent, consistent way is a powerful management tool for understanding how well the sales organization is functioning.

CFO Sales Advisory October 18, 2009

Deal Close Probabilities: SWAG vs. Zero Latitude

One of any sales forecasting systems critical tasks is estimating just how much business the sales organization will actually close. That is, youre trying to boil that (hopefully) giant pile of suspects and prospects down to a single, critical number. By far the most widely-used method for doing this is to assign a close probability to each deal, and the total forecast is then the sum of each deals size, times its close probability. But how should you assign a probability to each deal? You have two basic choices:

1. Sales management uses its best judgment to assign a probability to each deal.
2. The forecasting system assigns a probability to each deal, based on which of a series of predefined stages that deal is at in the sales cycle. (e.g., face-to-face meeting = 15%, delivered proposal = 35%, in contract negotiations = 90%, etc.)

Many argue that Method 1 (management judgment) is the more precise, since we all know sales is a complex, subjective process. Some bluebirds that arrive over the transom at the last minute do close, while some in the final stages of a months-long campaign dont. That observation is especially true since the object of all this computation is to estimate how much business will close in a given period.

Even so, my strong recommendation is to use Method 2 (the system assigns the probabilities), for the following reasons:

• Motivating behavior. Under Method 2, sales people know that the only way to make a deal seem nearer to closing is to complete a specific action (like having a meeting, delivering a proposal, getting something in writing from the customer, etc.).

• Reliability. Its asking a lot to require every sales manager to review and update the close probability of every deal in his or her territory every time you run the forecast. Is this really how you want managers to be spending their time?

• Consistency. Personality, style, and even cultural differences among sales managers may cause variations in how different managers will assess exactly the same deal.

• Personal agendas. One of the risks of Method 1 is that managers may alter probabilities to attract or deflect corporate attention, or simply to get the calculated territory forecast closer to the managers gut feel number. (Note that this is not always conscious behavior!)

• Relevance. Does all this really matter? Remember that the object of a sales forecasting system is to provide a consistent view of sales organization progress from period to period, and to motivate effective sales management. These are not quite the same as demanding that the weighted forecast halfway through the period exactly matches the eventual actual result.

I suggest that Method 1 is the better approach only if (a) your company typically has a relatively small number of relatively large deals in your pipeline, (b) sales managers typically get personally involved in the close process, and (c) the ways deals get closed in your company are so diverse that a standardized view of deal stages just doesnt make much sense anyway.

In my last post, I observed that trying to improve systems and processes sometimes causes us to forget that better is the enemy of good. Inputting close probabilities into a sales forecasting system is not only an example of that dynamic, but also shows that moderate precision that serves a real purpose is better than extreme precision thats pointless.

CFO Sales Advisory October 1, 2009

Forecasting Systems: Improvements Can Make Them Useless

A useful and effective sales forecasting system is one of the Holy Grails of sales management. The components of such a beast will be topics of this post from time to time. But before we address any of those components in detail, I offer this fundamental truth about forecasting systems: A mediocre system thats used consistently is better than a perfect system that isnt.

As profound as that statement may seem, its even deeper than that! Obviously, no forecasting system is credible unless every rep and manager whose input is required (the users) inputs reliably and consistently. Whats less obvious is this: Changes to the system, especially efforts to improve the system, can themselves have a significant impact on how reliably and consistently the system gets used. What if the changes you are considering will:

• Make inputting more time-consuming? Virtually all significant changes to the system processes require the users to spend more time inputting data. Its a slippery slope: the basic system just asks for prospect name and deal size, the next iteration asks for sales cycle stage, then product line detail, then activity summaries, and so on and so forth.

• Make inputting more complex? What if, for example, the proposed changes will require users to specify which of seven, rather than three, stages in the sales cycle each prospect is at? Or the changes mean inputting detailed product line information?

• Require more judgment and subjectivity? For example, one approach to assigning probability of close is to tie a single specific probability to each stage (e.g., 100% for closed, 90% for in contract negotiation, 75% for user signed off, etc.). Another approach requires a sales manager to input his or her own probability assessment for each deal. Which approach produces the more reliable weighted average forecast?

• Generate unwanted visibility? Additional detail in the system on each prospect is a two-edged sword. On the plus side, it enables company-wide collaboration to help close a deal, and provides valuable information. But from the sales forces perspective, that extra support may feel more like meddling, and an opportunity to be micromanaged.

• Benefit those other than the systems users? For example, detailed product line information on all prospects might be much more valuable to marketing or engineering, than to the users who are just trying to close deals.

Some of the consequences of these improvements can include:

• Input errors because the users just cant (or wont) devote sufficient time to inputting correctly,

• Input errors because the input procedures are more complicated,

• Inconsistent data in the system resulting from individual judgment and cultural differences,

• Data simply not entered, because users are concerned that (a) others will meddle, or (b) that they wont personally benefit, through increased sales, from the significant additional effort thats being asked of them.

Theres no question that a good sales forecasting system is a living, breathing animal that is constantly evolving. But every time you consider enhancing the system with the objective of getting more accurate, more reliable forecasts, you need to ask yourself: When does better become the enemy of good?

CFO Sales Advisory August 24, 2009

The New Rep Ramp-Up: Dont Let It Bite You!

It takes new sales reps one to four quarters before they start to perform at full speed. Thats especially true in businesses that depend on elephant hunting, where the bulk of the companys revenues come from a relatively small number of big deals. Those big deals take a long time to close, and depend on trusted relationship that take months or even years to build. Understanding this dynamic in a practical and realistic way can save sales executives and their companies from embarrassment and planning fiascos that are virtually impossible to recover from.

The key to planning properly for the New Rep Ramp-Up Effect is a quantified, realistic assessment of what a new rep can actually accomplish in his/her first few quarters. Suppose, for example, that a reasonable expectation for new reps at XYZ Corp. is zero in their first quarter on the job, 50% of full production in the second, and then full production thereafter. Lets further assume that the annual quota for an up-to-speed sales rep is $1,000,000, or $250,000 per quarter. If XYZ Corp. has 6 reps on board and fully up-to-speed at the beginning of 2010, with plans to hire 5 more during the year, heres a realistic assessment of what the sales force can produce:

Just because there will be 11 full-time sales reps on board by the end of 2010 is a terrible reason to commit to a corporate plan of $11MM. The above table suggests that a much more reasonable expectation for the year is $8.25MM. And the situation is even riskier than that: if some of the sales reps take longer to hire than expected, or even worse one of the new hires doesnt work out and XYZ Corp. needs to find a replacement, thats yet another hit to the companys ability to make its number. If XYZ Corp. was hoping to set a 2010 plan of, say, $10MM in revenues, they have two choices: (a) increase the hiring plan to generate the additional revenue, and do it soon enough in the year that the additional hires can be productive during 2010; or (b) revise the $10MM plan downward.

I have two principal recommendations for companies staring this sales rep ramp-up effect in the face, especially companies that are depending on as-yet-unhired sales people to contribute significantly:

1. Sales and financial management should work together to develop a clear, comprehensible model of new sales rep production, so everyone is on the same page.
2. In my last post on this Website, I advocated over-assigning quotas at every management level in the sales organization, to give everyone some breathing room on the plan numbers. The risk surrounding the sales rep ramp-up effect is a great example of the kind of dynamic that makes over-assigning quotas a wise thing to do.

CFO Sales Advisory August 9, 2009

Over-Assigning Quotas: A Power to Be Used for Good, Not for Evil

I'm wearingmy heart on my sleeve:I am a big fan of the practice of over-assigning sales quotas as part of a companys annual planning process. Its a practice that provides reasonable breathing room for people at all levels in the company, and protects sales management from its own aggressiveness and over-optimism.

To refresh everyones memory, over-assigning quotas means this: At a given level in the sales organization, the sum of the sales quotas of the sales reps (or managers) at that level is greater than the sum of the quotas of the sales manager(s) one level up. In larger companies, using the practice at multiple levels of sales management means that the difference between the sum of the quotas of the individual contributor sales reps and the corporate sales target can provide a pretty large cushion.

As someone who has spent many years in the CFOs chair, I like the practice because life tends to deal out more unpleasant surprises than pleasant ones. Yes, every so often somebody hits the jackpot, but lets face it: theres a reason why casinos are so profitable. And over-assigned quotas provide a win/win situation for people throughout the organization:

• Senior management and the board appreciate the increased certainty that the company will achieve its top-level goals, which may be well worth the cost of a few extra sales reps.

• Sales managers appreciate the cushion in case new-hire sales reps dont ramp up to full speed as quickly as hoped, or if unplanned turnover requires hiring new sales reps, who usually start at the bottom of the learning curve.

• Sales reps, not to mention the finance staff, appreciate the fact that the cushion reduces the pressure to perform unnatural acts like granting excessive discounts, or calling in favors, or worse in specific customer situations.

But I conclude with a warning: Dont ever create an over-assigned situation simply by raising the quotas at lower levels in the organization. That just doesnt work. Its destructive to morale and trust when you ask people to do more work for the same amount of pay, they feel like theyve gotten a pay cut. And if you fix that perception by also raising the target commissions at 100% of quota, youve lost some of the savings from keeping sales headcount down.

Moreover, its just not realistic to think that you can get a seasoned sales and sales management team to sell more just by telling them to sell more. Generally, that only works if the quotas were too low to begin with, and if that was the case, you have a different management problem.

CFO Sales Advisory July 15, 2009

Projecting Commission Expensew/Accelerated Plans the Snow White and the Seven Dwarfs Effect

As we discussed in a previous post, accelerated commission plans are a powerful motivational and management tool. But if you dont plan for them properly, you can have some ugly surprises when its time to write the checks or to explain your results to your investors.

Were referring to what is sometimes called the Snow White and the Seven Dwarfs effect. Consider the accelerated plan we described earlier, in a company with five sales reps and a corporate revenue target of $5,000,000, where each rep has the same quota and target commission. Heres how those five reps might do under one scenario:

Production Commission

Fred $ 3,000,000 $ 500,000

Mary 750,000 68,000

Howard 600,000 48,000

Louise 500,000 37,000

Martin 150,000 9,000

TOTAL $ 5,000,000 $ 662,000

The good news is that as a whole, the company did fine, hitting their $5,000,000 target right on the nose. But instead of having five reps each earning $100,000 (what reps earn at exactly 100% of the $1,000,000 individual quota) for a total commission payout of $500,000, the total bill for commissions comes to a hefty $662,000. Thats $162,000, or more than 3% of revenues, above what it would be given level performance by each rep.

Is this a problem? It shouldnt be: you should never have expected performance to be evenly distributed across an entire sales force that just doesnt happen in real life, especially in businesses where big deals are typical. This is a budgeting problem, not a sales management or a cost control problem. But even so, a large unfavorable commission expense variance when sales were right at expectations is pretty embarrassing.

To avoid this problem, its critical that sales and finance work together to estimate what the average sales rep will earn if the company achieves its plan. A key part of that is estimating the probable mix between Snow Whites and Dwarfs. Start with your companys historical distribution of sales rep performance over the last couple of years. You can also use common sense, based on the experience of seasoned finance and sales managers. Overlaying that likely distribution onto your companys current accelerated commission plan should give you a clear idea of how much commission expense you should really expect.

Accelerated sales commission plans are a great idea, especially in earlier-stage companies where a relatively small number of big deals make a huge difference. Just dont find yourself in the embarrassing position of having to explain unpleasant commission expense surprises.

CFO Sales Advisory July 1,2009

Accelerated Comp Plans Sometimes the Rich Should Get Richer

Accelerated compensation plans are those where the commission rate increases as the recipients performance against quota increases. Theyare a powerful motivational and sales management tool, especially for earlier-stage companies where a relatively small number of big deals can make a huge difference.

How do accelerated plans work? Well, in an example where the reps target commissions are $100,000 for delivering quota results of $1,000,000, commissions under various performance scenarios might look like this:

PRODUCTION COMMISSION COMMISSION RATES

$$ % of Quota $$ % Target Comp Overall Incremental

1,000,000 100% 100,000 100% 10.0% 10.0%

2,000,000 200% 250,000 250% 12.5% 15.0%

3,000,000 300% 500,000 500% 16.7% 25.0%

There is also typically a decelerator on underperformance, so that a rep who only delivered $700,000 (i.e., 70% of quota) might earn only, say, $60,000 (i.e., 60% of target comp).

Accelerated comp plans have these important benefits:

• Theyre a great recruiting tool, because big producers can see big income potential.

• Theyre a great retention tool, for the same reason.

• A sales rep in the middle of a great year is motivated to keep pouring it on because of the accelerated commission rates, rather than coasting for the rest of the year.

• The extra commission dollars are often less than the additional base salary, benefits, office, travel & entertainment, and other costs incurred by having several average or below-average producers instead of one big producer.

• Underperforming sales reps get the message in their paychecks.

At the same time, accelerated plans need to be crafted carefully because of the larger dollar amounts involved, so plan design flaws can be especially costly. Also, corporate directors, managers, and administrators need to understand them well enough to ensure that the incentive benefits such plans offer are maximized, and that may take extra effort because the math in these plans is a little more complex.

Finally, communicating accelerated comp plans to the participants is just as important as designing a good plan. Theres no point to having expensive plans like this unless the plans themselves help to drive the desired behavior in the first place, and thats only going to happen when the sales people and other participants know exactly how the plans work. That requires not just communicating, but selling the participants on their value.

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Randy is the CEO of Lucidity, a consulting/coaching practice focused on enterprise finance tasks such as incentive compensation plans, reporting packages, and business models. He is passionate about the importance of presenting financials and other quantitative information in a cogent and effective way. He believes strongly that doing this well is a communication skill, and not a black art practiced by the 'numbers guys."

Mr. Bolten's perspective comes from financial executive assignments and CFO, for public companies BroadVision and Pheonix Technologies, Corporate Controller at Oracle and financial management positions at Tandem Computers. He has an MBA from Stanford and an AB from Princeton.

Randy is the author of the forthcoming book, Painting with Numbers: Presenting Financials and Other Numbers as if You Were Actually Trying to Say Something, and write posts periodically about the hot numbers-related topics of the moment on his website, www.painting-with-numbers.com

Check out our continuing series on Sales & Finance issues with Randy Bolten*, former Controller with Oracle and CFO at Broadvision -

If we can help you with business issues that deal with the Sales team, let us know at comp@121siliconvalley.com