How to Calculate On-Target Earnings (OTE) in Compensation Plans

On-Target Earnings (OTE) are a cornerstone of effective compensation plans, particularly in sales and performance-based roles. OTE represents the total potential income an employee can earn if they meet 100% of their targets. Calculating OTE accurately ensures clarity, fairness, and motivation within your team. In this article we will provide a step-by-step guide to calculating OTE and understanding its components.

How to Calculate On-Target Earnings (OTE): A Step-by-Step Guide

1. Determine the Base Salary

The base salary is the fixed part of On-Target Earnings (OTE), providing financial stability. It remains constant, unaffected by performance, and acts as a safety net. It's determined by industry standards, job role, experience, and market conditions.

Example:
If a sales representative’s annual base salary is $60,000, this forms the foundation of their OTE.

2. Define the Variable Pay Component

Variable pay includes commissions, bonuses, or other performance-based incentives that reward employees for meeting or exceeding targets. It ties earnings to performance, motivating employees to excel. This approach benefits both employees, who can increase their earnings, and the organization, which achieves its goals more efficiently with a motivated team.

Steps to define variable pay:

• Set the commission structure: Decide if the commission is a flat rate or tiered, and whether you want to include other components to create the bonus or commission structure you're after.
• Determine bonus eligibility: Specify any performance milestones or KPIs required. 

Example:
If the target commission or bonus is $40,000 for meeting all sales goals, the maximum bonus one can achieve, this is the variable component.

3. Establish Performance Targets (KPIs)

Set clear, measurable performance targets that employees must achieve to earn the variable pay. These targets are often tied to sales quotas, revenue goals, or other metrics. These benchmarks help employees understand expectations and align their efforts with company objectives. Regularly review and adjust targets to stay relevant and attainable. To make the incentive scheme fair and reduce the risk of subjective performance assessments, ensure that the KPIs are measurable and attainable by all participants.

Key considerations:

• Ensure targets are realistic and data-driven.
• Align targets with company objectives.

Example:
A sales target could be $500,000 in annual revenue to earn the full $40,000 commission.

4. Calculate Total OTE

To determine the total On-Target Earnings (OTE), you need to combine both the base salary and the variable pay components. Start by identifying the base salary, which is the fixed amount an employee receives regardless of performance. Next, calculate the variable pay, which includes any commissions, bonuses, or performance-based incentives that the employee is eligible to earn by meeting or exceeding their targets.

By adding these two figures together, you arrive at the total OTE, which represents the full potential earnings an employee can achieve when they meet all their performance goals. This calculation is crucial as it provides a clear picture of the financial rewards available, motivating employees to strive for excellence and align their efforts with the company's objectives.

Formula:

OTE = Base Salary + Variable Pay 

Example Calculation:

• Base Salary: $60,000
• Variable Pay: $40,000

OTE = 60,000 + 40,000 = 100,000

The OTE for this role is $100,000.

5. Factor in Accelerators and Decelerators

Some compensation plans use accelerators to reward employees who exceed targets, offering extra incentives like higher commissions or bonuses. Conversely, decelerators reduce pay if targets aren't met, tying compensation to performance. This strategy motivates employees and manages costs, ensuring rewards are fair and aligned with company goals. Visit our glossary to learn about other components you can include in your compensation plan.

Example:

• Accelerator: 10% extra commission for 110% target achievement.
• Decelerator: 20% reduction in commission if only 80% of the target is met.

OTE Calculation Example Scenario

1. Base Salary: $50,000
2. Target Commission: $30,000 for $300,000 in sales.
3. Accelerator: Additional $5,000 if sales reach $350,000.

Result:

• Hitting $300,000 in sales = $50,000 (base) + $30,000 (commission) = $80,000 OTE.
• Exceeding $350,000 in sales = $80,000 + $5,000 = $85,000 on-target earnings.

Why Accurate OTE Calculation Matters

Understanding why On-Target Earnings (OTE) is important is crucial for both employers and employees. OTE serves as a comprehensive framework that aligns individual performance with organizational objectives, ensuring that employees are not only aware of their earning potential but are also motivated to achieve it which impact the company in multiple ways:

• Transparency: 

  Clear On-Target Earnings (OTE) expectations reduce disputes and foster harmony between employees and management. Transparency in earnings structure minimizes misunderstandings, helps set realistic goals, and builds trust, ensuring employees feel fairly rewarded.

• Motivation: 

  Clear understanding of potential earnings motivates employees to meet and exceed targets. Visualizing financial rewards tied to performance encourages focus, task prioritization, and striving for excellence, leading to higher productivity and job satisfaction.

• Retention: 

  Competitive and fair OTE structures attract and retain top talent by offering equitable, rewarding compensation plans. These plans appeal to high performers seeking financial stability and the chance to maximize earnings. A well-structured OTE plan shows a company's commitment to valuing employees, fostering loyalty, reducing turnover, and enhancing its reputation as an employer of choice, making it easier to recruit skilled professionals.

Final Thoughts

Calculating On-Target Earnings involves understanding and balancing base salary, variable pay, and performance metrics. A well-designed OTE structure ensures that compensation plans are motivating, transparent, and aligned with organizational goals.

Looking to optimize your compensation strategy? Bentega.io offers tools and expertise to help you design and implement effective OTE plans tailored to your business needs.