Your employee’s performance directly impacts your company’s revenue. Whether it's sales, customer service, or business development, the better they do, the better you do. However, setting expectations, keeping morale high, and boosting performance is often a tough task for CFOs.
The million-dollar question: how do you keep your employees incentivized to reach and even exceed their targets?
On-target earnings (OTEs) is your answer.
On-target earning is a payment model that directly links your employees’ compensation to their performance and ensures their goals are aligned with your company’s objectives. With on-target earnings, employees are given a base salary alongside a commission that’s based on the performance goals they meet (or don’t meet).
In this guide, we explain what on-target earnings are, their strengths and limitations, and how to calculate them. We finish with four key factors to consider before offering OTE payment structures to employees.
Key takeaways:
- On-target earnings (OTEs) are the total amount of money an employee can expect to earn through achieving their set performance targets or 100% of their quota.
- OTEs have two basic components including a base salary and commission, making up what's known as a pay mix.
- To calculate OTEs with its two basic components, follow this simple formula:
<Base salary> + <commission earned at 100% of sales quota> = on-target earnings (OTEs)
- More complex products, services, and sales funnels require a larger commission to motivate employees operating under OTEs payment structures—as they can be harder to sell and have longer sales cycles.
- Capped OTE places a maximum amount of commissions an employee can earn by achieving performance marks while uncapped OTE gives employees unlimited earning potential through commissions.
What Is On-Target Earning (OTE)?
On-target earnings (OTEs) are the total amount of money an employee can expect to earn through achieving their set performance targets or 100% of their quota. Typically, companies calculate OTE through yearly earnings, or quarterly and monthly for shorter contracts with their employees.
OTEs motivate employees to meet company objectives and compensate them more for strong performances—everybody wins.
For example, a company job posting may read $90,000 on target earnings, meaning employees can expect to take home that amount yearly—provided they meet all of their quotas, all of the time.
The OTE payment structure is made up of several components, also known as a pay mix. Let’s see what a typical OTE pay mix consists of.
What Is the Pay Mix of an On-Target Earning?
The OTE pay mix consists of two major components:
- Base salary: The guaranteed salary employees receive regardless of whether they meet quotas or not. This component provides employees with security and stability, an important part of attracting talent.
- Commission: Performance-based earnings that employees receive if they achieve their targets. In sales, for example, this could be a fixed percentage of the sales revenue agreed on by the company and an employee.
Some OTEs also have a third component as an additional incentive for hitting fixed milestones, otherwise known as bonuses—which we’ll talk about more when we discuss calculating OTEs. The exact amount for each component will depend on your company’s compensation budget.
All components considered, is the OTE method the best way to compensate your employees? Let's find out.
The Strengths and Limitations of Using On-Target Earnings as a Compensation Structure
An OTE-based compensation model can be ideal for incentivizing employees and meeting important business objectives when applied in the right context. However, it’s not without some disadvantages.
Some of the pros you can expect with OTEs are:
- Setting expectations for potential hires: New employees will know exactly what their objectives are, and can quickly go about achieving them
- Employee motivation and retention: With OTE commissions, your employees have the chance to earn more. This earning potential acts as a motivating factor and a reason to stay at your company.
- Aligns employee goals with business objectives: Setting metrics for employees ensures they’re applying time and effort to achieve vital company objectives
- Provides financial clarity for both employees and employers: With an established OTE structure, both your company and your employees will be able to better manage their finances with a predictable base salary and clear commission structure
- Focuses employee efforts on measurable results: Employees will be able to spend their time and effort on achieving results that are trackable, helping them understand how much they’re contributing to fulfilling business objectives
Some of the main cons of OTEs are:
- It’s subject to market trends, slumps, and downturns: Sometimes, employees won’t be able to achieve performance metrics due to negative economic trends that are out of their control, leading to diminished cash flow and morale
- Can be high-pressure if not implemented carefully: Commission from OTEs puts pressure on an employee to perform. If not guided correctly, this can lead to additional stress and even burnout.
- Tracking OTE can be time-consuming and complex: OTE is made up of multiple components that require frequent calculations for paying out commissions. This can be resource-intensive to manually track.
- Can promote speed over quality: Employees on an OTE payment structure can be more inclined to cut corners in order to make sales, meaning they could end up missing key details
Weighing up the benefits of these advantages against the risks of these drawbacks is key for deciding whether an OTE payment structure is right for you.
This will also vastly depend on your business or team structures. Sales, customer success, and even product teams are examples where OTEs can be especially helpful. Darren Heath, Head of Telesales at Creative Car Park Ltd, shares his thoughts on OTE as a salary structure in sales roles:
“Working for blue chip companies and start-ups alike, on-target earning potential is super-important. Especially where growth is the key objective for a business. It's a great way to incentivize employees. In my opinion an OTE boosts length of service amongst top performers and allows a business to raise standards. Employees start to think long-term with plans linked to potential earnings. So it's a win-win.”
On the other hand, technical, operational, and creative efforts aren’t directly tied to revenue, making them less suitable for OTE payment structures.
Ray Slater Berry, Founder at dslx, shares his experience offering commission as a way to reward account managers at his content agency:
“We previously offered Account Managers at dslx a percentage of the profits on the accounts they managed, but we found that this led to poorer quality work and, subsequently, unhappy customers. Instead of investing in the necessary resources for projects, such as bringing in external expertise, some AMs were reluctant to spend on their accounts as it ate into the final profit margin. When we realized this, we changed the way we compensate team members for their success.”
➕ Cledara tip: Worried that introducing OTEs will promote individual achievement over teamwork throughout your organization? Consider implementing team-wide OTE structures with team performance metrics. For example, you can establish shared targets your entire team needs to achieve to unlock bonuses. This method encourages collaboration and support while still motivating performance.
Now that you understand both the benefits and drawbacks of OTEs, it’s time to look into calculating the specific components of this payment structure.
How to Calculate On-Target Earnings?
To calculate OTE, plug the different components of your pay mix into this simple formula:
<Base salary> + <commission earned at 100% of sales quota> = on-target earnings (OTE)
Let’s look at this in action with an example of how to calculate an OTE salary.
Imagine you’re hiring for a sales position. First, you could settle on an annual base salary of $55,000. You land on this figure by considering the market rate for the position, and where within the salary bracket your company is looking to hire.
To calculate the commission you can offer for this role, you first need to consider your annual sales target. Let’s say, based on company goals and predictions, your annual sales target is $500,000 per employee.
Once you’ve got this, you then need to decide how big a percentage of the commission you’re willing to offer employees who meet their targets. In this case, let’s say you offer a competitive commission of 5% of each sale they make.
Using these two figures, you can calculate how much commission an employee will earn given they hit their goals. To do this you multiply the total sales revenue by your commission rate.
That brings you to:
$500,000 x 0.05= $25,000 OTE commission
You then add your base salary and commission together to get your total annual OTE salary:
$55,000 + $25,000 = $80,000 OTE
This is the figure you’ll advertise in the job posting. It’s the compensation employees will get if they successfully meet their yearly goals.
Now, let’s say you want to reward high-performing employees even more by adding a bonus for exceeding their targets. There are several ways you can calculate what bonus to offer employees, with a popular option being to offer a percentage of their salary.
Let’s say you’ll offer a 5% of salary bonus to employees who exceed their performance goals:
$80,000 x 0.05 = $4,000 bonus
When adding bonuses to your OTE mix, the formula is as follows:
<Base salary> + <commission earned at 100% of sales quota> + <bonus> = on-target earnings (OTE)
So, with your base salary, OTE commission, and additional bonus for above-and-beyond performance, you arrive at:
$55,000 + $25,000 + $4,000 = $84,000 OTE
➕ Cledara tip: Clients sometimes back out of deals unexpectedly. To account for early churn, establish a commission claw-back policy and communicate it to your employees. For example, a policy might take back commissions if a new customer cancels within the first 90 days.
4 Questions to Answer Before Offering On-Target Earnings to Employees
The particulars of your final OTE structure will vary depending on the roles you’re hiring for, your sales cycle, the type of OTE you choose, and the complexity of your products or services. Other factors include your industry benchmarks, financial plans, and long-term business objectives.
Let’s look at the key considerations when choosing an OTE model for compensation.
1. What Role Is Using the On-Target Earnings Model?
As a general rule of thumb, use OTE models for positions where employee performance directly influences your company’s revenue and profit. For an OTE model to work efficiently, you need to be able to measure performance through specific benchmarks and key performance indicators (KPIs).
Some specific roles where OTE is oftentimes the norm include:
- Sales representatives: Responsible for selling products or services to customers, sales reps directly influence a company’s profit. Typical deciding factors for OTE compensation include the number of deals closed, the percentage of sales targets met (quotas), or sales revenue achieved during a specific period.
- Account executives: With the role of increasing revenue from attained accounts, you can incentivize account executives with a commission based on the percentage of customers retained over a specific period or even for upselling services to clients
- Business development managers: Generate leads, forge new partnerships, and nurture customer relationships. An OTE model makes it efficient to reward business developers for the number of new markets they successfully enter or the percentage of new business opportunities they convert into sales.
- Recruiters: Many companies incentivize recruiters with commissions based on successful talent placements or even the revenue generated through a new hire
- Customer success managers: OTE models for compensating customer success managers include metrics such as customer satisfaction scores (CSAT), renewal rates, and customer retention rates
Head of Telesales, Darren, shares his thoughts on this consideration when calculating OTE:
“Companies may consider the return on investment over a period of time to justify commission offered. Contract length will also play a part as there would be a difference between a product/service that has a 10 year lifespan compared to product/service that has a 2 year lifespan. If you have Business Development Executives feeding sales opportunities to Field Sales, the closing of deals happens with Field Sales. Therefore, the tendency is to reward Field Sales at a higher rate.”
The level of each position will also influence the OTE mix for employees. For example, an entry-level customer success agent will have substantially different commissions than a senior sales manager.
2. How Long Is the Sales Cycle?
Not all sales cycles are created equal—and you need to keep this in mind when establishing an OTE model. For example, B2B sales cycles are generally longer, and more complex (more on that shortly), than B2C sales cycles.
It typically takes B2B sales representatives more time to successfully guide potential customers through the funnel and persuade them to buy your product or service. This longer sales cycle means that it can take more time for sales representatives to see success (and commission)—meaning sales representatives will need extra motivation and incentives from higher commissions to make consistent sales and keep morale high.
B2C sales cycles often warrant less of a commission in the OTE mix. A shorter sales cycle also means that sales representatives have the opportunity to close deals more often, meaning they receive commissions faster.
➕ Cledara tip: If you’re dealing with a longer sales cycle for your product or service, make sure that your finance planning and forecasting accounts for this factor. Consider looking at metrics less frequently, but in more detail to effectively manage your sales representative’s success in the long-term. Try an AI finance tool to help!
3. How Complex Are Your Products and Services?
The complexity of your product or service also influences your OTE components for compensation.
For example, more complicated services, such as B2B SaaS, involve a requirement for in-depth technical knowledge and more invested effort in customer education and relationship management. As such, compensation for selling SaaS may require larger commissions if you aim to attract and retain high-performing talent.
Less technical products, such as consumer electronics or retail and lifestyle products, make it easy to communicate a product’s value proposition and guide potential customers through a simpler sales funnel.
4. Should You Use Capped and Uncapped On-Target Earnings?
There are two types of OTE, and they impact whether the commission you pay to employees has a limit or not:
Capped OTE
Places a maximum amount of commissions an employee can earn by hitting their targets. Once this cap is reached, your employee will not receive more commission regardless of their performance beyond the cap (given you don’t offer a bonus).
Benefits
- Easy to predict compensation costs with fixed commission potential
- Easier financial planning and budget reporting
- Low risk of excessive payouts
Drawbacks
- Loss of motivation of high performers once the cap is reached
- Diminished team morale due to less earning potential
- Higher turnover of employees seeking more lucrative opportunities
Uncapped OTE
Means there is no maximum limit to what an employee can earn through commission. As long as they keep hitting and exceeding performance targets, they stand to receive more commission.
Benefits
- High motivations for employers to exceed targets
- Attracts top-performing talent
- High employee satisfaction because of unlimited earning potential
Drawbacks
- Complicated budgeting and unpredictable compensation costs
- A risk of excessive payouts if employees achieve results that are unaccounted for
- Can indirectly encourage aggressive sales tactics as employees focus primarily on commission, potentially harming customer relationships
Which is right for your company? Your choice will ultimately depend on your company’s culture, budget, roles, and business structure.
➕ Cledara tip: You don’t need to settle for uncapped or capped OTEs across your whole organization. While it can complicate your financial planning, you can assign different OTE structures to employees depending on their roles, responsibilities, and team.
Incentivize Employees with On-Target Earnings and Drive Revenue
OTE directly links your employee’s compensation to their performance. Introducing commissions and bonuses to their base salary helps you reward them for helping achieve your business’s short-term and long-term objectives.
Before settling on an OTE structure for new positions, make sure to assess crucial factors such as capped and uncapped models, quota ratios, and sales cycle complexity.
With these key factors in mind, you’re ready to implement OTE payment structures and incentivize employees that directly impact your company’s revenue.
