For sales professionals, especially in roles that are commission-based, "On-Target Earnings" (OTE) is a frequently used metric to represent their potential compensation. It’s an essential part of structuring effective and transparent compensation plans. But what exactly is OTE, and why is it important for salespeople and their leaders? This article dives into the components of OTE, explains how it’s calculated, and explores best practices for setting achievable targets that drive high performance.
What is On-Target Earnings (OTE)?
On-Target Earnings (OTE) is the total expected earnings for a salesperson when they reach their predefined sales goals or quotas. Unlike base salary alone, OTE combines both fixed and variable components of a salesperson's compensation package, offering a clear picture of potential earnings if they meet their targets.
This metric is crucial for three primary reasons:
- Transparency: OTE provides salespeople with a clear understanding of their earning potential, motivating them to perform at their best.
- Expectation Setting: It allows companies to set realistic sales expectations that align with their revenue goals.
- Retention and Motivation: Competitive OTEs attract and keep top talent. They make the pay structure motivating and easy to reach.
Breaking Down the Components of OTE
On-target earnings are comprised of two main components: base salary and variable pay. Let’s look at each component in detail.
- Base Salary: This is the fixed portion of a salesperson's income, paid regardless of performance. Base salary varies depending on the role, industry, and level of experience. For example, a high-tech software sales job may pay more than a retail sales job. This is due to the special knowledge and skills needed.
- Variable Pay (Commission and Bonuses): This is the performance-based part of a salesperson's compensation, often tied directly to sales targets or quotas. The variable portion typically includes:
- Commission: A percentage of each sale made, calculated based on the revenue or profit generated.
- Bonuses: Incentives for reaching specific targets, often awarded at the end of a quarter or fiscal year. Bonuses might be offered for achieving a certain percentage of a sales quota (like 100%) or exceeding targets (e.g., 120%).
Calculating OTE
The formula for calculating OTE is relatively straightforward:
OTE = Base Salary + Target Variable Pay
For example, consider a sales development representative (SDR) with an annual base salary of $50,000 and a target variable pay (commission and bonuses) of $30,000. Their OTE would be:
OTE = $50,000 (Base Salary) + $30,000 (Variable Pay) = $80,000
This $80,000 represents the earnings they can expect if they meet their targets. The structure can vary based on the sales role. Some positions offer a 50/50 split, meaning base salary and variable pay are equal. Other roles may have different ratios, such as 70/30 or 60/40.
Example of an OTE Compensation Plan
To better understand OTE in action, let’s look at a sample compensation plan for an Account Executive in a SaaS company:
- Base Salary: $60,000
- Target Variable Pay: $40,000
In this case, the OTE would be $100,000.
The variable pay could be structured as follows:
- Commission on New Sales: 8% of the revenue from each new sale.
- Quarterly Bonus: $5,000 for achieving 100% of the quarterly quota.
So, if the account executive achieves their quarterly goals every quarter and sells $500,000 worth of software, their compensation would look like this:
- Annual Base Salary: $60,000
- Annual Commission: 8% of $500,000 = $40,000
- Quarterly Bonuses: $5,000 per quarter × 4 = $20,000
Total Earnings for the Year = $60,000 (Base) + $40,000 (Commission) + $20,000 (Bonuses) = $120,000
Here, the total compensation exceeds the OTE due to high performance, a strong incentive for the salesperson to go beyond the basic targets.
Best Practices for Setting and Managing OTE
To ensure OTE drives optimal performance, companies need to set realistic and motivating targets. Here are some best practices:
- Align OTE with Market Standards: Competitive OTE is essential to attracting and retaining top sales talent. Regularly benchmark compensation plans to ensure alignment with industry standards.
- Set Achievable Quotas: OTE should reflect a target that is challenging but achievable. If quotas are too high, salespeople may become discouraged, viewing their OTE as unachievable. Regularly review and adjust quotas based on market conditions, product demand, and sales cycle length.
- Create a Clear Pay Mix: The balance between base salary and variable pay should be clear. It should relate to the role and match sales goals. For example, roles heavily focused on prospecting may lean towards a higher base salary, while roles with more direct selling might benefit from a higher variable component.
- Incorporate SPIFF Programs for Extra Motivation: Special Performance Incentive Funds (SPIFFs) are short-term incentives designed to motivate sales teams to meet specific goals. For example, offering a $500 SPIFF for every new customer signed within a month can provide a quick boost in motivation and help salespeople earn beyond their OTE.
- Offer Accelerators for Exceeding Targets: Encourage overachievement by implementing accelerators that increase the commission rate once salespeople exceed their targets. For example, an Account Executive might receive 8% commission on all sales until they hit their annual target, after which the commission rate increases to 10%.
Conclusion
On-target earnings are a key part of a good sales compensation plan. They give salespeople a clear view of how much they can earn. This helps motivate them to perform at their best. By understanding the components of OTE and implementing best practices, companies can ensure their compensation plans are both motivating and achievable, ultimately driving better results for both the sales team and the organization as a whole. Setting a well-structured OTE can empower sales teams, increase retention, and support sustained growth.