Why founders should care about OTE

If you are considering the best way to structure or re-structure your commission plan, then OTE is an essential place to start. Having a defined OTE ensures your Sales team have transparency of the commission plan and are motivated to hit sales targets. It also ensures your business can effectively plan and manage its budget.
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What is OTE?

OTE (On-target earnings or on-track earnings) refers to an employee’s total pay structure, which can be made up of their basic salary as well as an additional variable component like commissions and or bonuses.

So, if your sales rep’s annual base salary is $60,000 and their on-target commission is $40,000, their OTE will be $100,000, provided they hit all sales goals. If they don’t reach all their goals, they would still receive the base salary plus whatever portion of the commission they did earn.
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These same amounts can also be discussed as a ratio of the base + variable, this is often called a pay mix. and it’s simply the % make up of the base salary figure and the variable component that ads up to 100%. So in the above example this pay mix looks like this 60/40 and is an easy way to discuss the compensation plans with your staff.

‍Why is it important?

OTE helps a company to determine the fully-loaded cost for a sales rep, but it’s also a really good bellwether around the certainty vs risk that an employee takes on joining your business. Having this certainty and predictability of the costs of a fully-loaded sales team assists with budget forecasting and target setting.

Here are 3 more reasons to use OTE as a sales compensation model:

1. Transparency: For both the company and the sales rep, it is an easy way to understand causality between hitting targets and the payout or cost to business.
2. Motivation: Having a clear goal set out right from the beginning allows a salesperson to know where they are heading and feel motivated that they can hit those targets.
3. Target setting: In David Skok’s analysis of sales comp, he discusses the Unit Economics of a Salesperson and concludes that ‘when your sales process starts to work well, quotas should be at least 5x the OTE (On Target Earnings), which includes base salary + bonus. Ideally quotas are 6–8X OTE to be considered high performing. These are guidelines we’ve observed based on empirical data from a number of successful companies we’ve worked with. But, this is just a guideline. The complexity and difficulty of your sale will determine the ratio your business can support.’

The higher the base, the greater the certainty or security this employee will have around their compensation. On the flip-side the businesses will also want to highly motivate sales staff to achieve their targets — in this case a lower pay mix of 50/50 may drive motivation and the desired behaviour.
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• Higher productivity. Incentivised to hit OTE, the OTE is an effective way to help wth sales reps put more effort into achieving their sales goals and setting up new deals for the next quarter. They will ensure they have a good pipeline of sales deals in case one falls through.
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• Company’s growth. A good compensation plan will help your sales team not only hit the Sales goal but will support the broader Company goals. Having your sales activity and company goals closely aligned, will ensure your company sees growth quarter on quarter.
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How do I decide the pay mix?

To help calculate OTE, you first determine the pay mix (the ratio of a base salary to commissions).

There are several factors that influence the way a company will decide on pay mix ratio:

• The role/position There will be a mix of sales roles in your organisation as well as differing experience levels. A Business Development Rep and a Senior Territory Exec will have different responsibilities and bring a differing level of experience to the role, so would need to be compensated accordingly.
• Market rate You’re obviously looking for the best person for the job, but there will be strong competition for this person. You need to consider what the OTE is in the market as the best and brightest will flock to higher OTEs with achievable targets.
• The product/service complexity: If you have a more complex product or service, you will need a salesforce that has the industry experience and technical expertise to successfully sell your product/service. Therefore, you’ll need to consider a higher pay mix to compensate and retain your staff. If you have put time and money into product training, you need to consider the loss by staff attrition by not compensating them effectively.
• Sales cycle length: SaaS companies typically have longer sales cycles and therefore require more effort and motivation, so therefore should be considering a higher pay mix. In comparison, Retail sales teams receive a smaller pay mix as the sales cycle is much shorter and transactional.
• Company philosophy: How your structure your pay mix may also be influenced by the culture and philosophy of your organisation. Some companies want to show a level of generosity that is balanced with fiscal responsibility. Another company may take a more conservative approach to help mitigate risks.
• Stage of business — If you have little in the way of past sales records and you’re an early stage business, you may struggle to determine the quota for the business. One way to get around this for your pay mix to be a higher base with a lower variable to offer security whilst your sales reps need to complete non-selling responsibilities (like codifying the sales process). This is typical when it’s still a founder led sales organisation.

Can someone exceed their OTE?

In short, yes. OTE is for budget planning so a business understands what the fully-loaded costs are for each member. However, many companies will have a commission structure that rewards a Sales Rep for exceeding their quota. If a business implements accelerators that reward high achievers, you can expect a small number of them to earn more than their OTE. Without these accelerators, Harvard Business Review research suggests ‘that caps on commissions, which most large companies use, decrease high-performing reps’ motivation and effort.’

What about new employees?

• The on-target-earnings is for a fully ramped up sales member. Depending on how long it takes to onboard and your new employee to start hitting their targets, they can expect a lower OTE on their first year of employment unless you adjust their 1st-year targets. It’s important to address this with your new employees so they understand that the OTE is based upon them being a fully productive member of the sales team. It’s for this reason that many businesses employ something called a ramp, where targets are reduced for the initial months, but then ramps up to their full quota after the ramp period is complete — this then allows them to still achieve their expected OTE.
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