Rocket Readings: Does Your Variable Compensation Plan Account for Revenue Lag?

Does Your Variable Compensation Plan Account for Revenue Lag?:

One of the most challenging variable compensation plans to design is one that accounts for revenue lag. Revenue lag is the time span between a signed order and revenue recognition. This is common in industries such as semiconductors, software, capital equipment and custom technology. To better understand how companies should approach this type of incentive compensation plan, I spoke with Mike Balow, Vice President of Sales for Integrated Device Technology, a $650M semiconductor company headquartered in San Designing Variable Compensation Plan Jose, CA.

Ryan: Mike, what are the key challenges in designing variable compensation plans in your industry?

Mike: There are 18-24 months from the time we win a design with a customer until they begin production and we start to see revenue. The challenge companies in our industry face is paying for something that doesn’t materialize for two years.

R: How do you incent a rep to perform in that type of environment?

M: In my opinion, it’s not really an incentive plan at all if you only focus on revenue. A rep can’t go out and make the number change from quarter to quarter like in most industries. The revenue coming in today is a result of business won in the past. Your sales compensation planning has to create incentives that reps can achieve in the short term that are leading indicators of future revenue.

R: What does that type of plan look like?

M: In our business, you have to look at the commitments the rep is getting from the customer base. We want reps winning designs every quarter. If they are winning deals now, we will see the revenue later.

R: Isn’t it dangerous to pay on commitments? After all, who says it will convert into actual revenue dollars?

M: You have to validate the pipeline and know what the historical leakage is.

R: What is leakage?

M: It’s the amount of revenue that falls out of the funnel from commitment to revenue recognition. For example, if you sign a deal for $100 and it converts to $95 in actual revenue, your leakage is 5%. Knowing this is critical to ensure you don’t overpay on commitments.

R: Do reps respond well to this type of plan?

M: You have to incent your ‘A’ players to perform like ‘A’ players. Knowing how your business performs based on committed revenue enables you to deploy short term sales incentive plan goals that keep your top performers focused on the key objectives. If you can provide them with a way to earn commissions every quarter, they will respond and you will start seeing results on the revenue side.

Call to Action:

When it comes to designing sales incentive plans for companies with revenue lag, focus on leakage and the short term results your sales reps generate that lead to long term revenue.

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