How to Calculate OTE Compensation for Employees: Examples

OTE compensation is a way to reward your team for their performance, set clear expectations, and motivate them to reach their targets. Research shows that performance-based pay, like OTE, seems to encourage employees to work harder and drive better results for the company.

So, So, what does OTE mean? How do you calculate it? This article explains OTE compensation meaning, provides a step-by-step guide on how to calculate it, and offers example calculations. Along the way, we'll also include an easy solution for calculation to streamline your compensation process.

What are on-target earnings (OTE)?

OTE compensation, or on-target earnings, is a pay structure where an employee receives a base salary plus a set commission for meeting specific targets. It’s often listed in job postings to show candidates their potential total earnings if goals are met.

For example, candidates may see a job posting with an OTE of $100,000. This OTE may include a $60,000 base salary and up to $40,000 in commission based on sales performance.

An OTE pay structure is especially common in performance-driven roles, particularly in sales. Positions that often use on-target earnings include:

• sales representative

• sales manager

• account executive

• marketing director

• Real estate agent, and more.

To calculate OTE compensation, add the annual base salary and the commission earned for hitting 100% of the target. For example, a sales representative with a $65,000 base salary and $45,000 commission would have on-target earnings of $110,000.

Many organizations still use outdated tools like spreadsheets to calculate performance-based compensation, such as commissions. With Salary.com's Compensation Planning Software, managing merit raises, bonuses, commissions, long-term incentives, and equity becomes easier than ever.

How does OTE compensation work?

As mentioned earlier, OTE works by combining a fixed base salary with a variable component, such as commissions or bonuses, based on performance. The base salary ensures financial stability, while the variable pay motivates employees to meet specific targets.

Targets, often tied to sales quotas or key performance indicators (KPIs), are set by the employer. If employees meet 100% of their targets, they earn their full on-target earnings. The variable pay is typically a percentage of the target achieved or a tiered structure with higher rewards for better performance.

According to IRS Publication 15, all wages subject to federal employment taxes include any pay an employee receives for services. Therefore, since OTE compensation, such as commissions, is considered income, it is subject to federal income tax.

Benefits and challenges of OTE compensation

Below are the benefits and challenges of having OTE compensation for an organization:

Advantages

• OTE encourages employees to do their best: When part of the pay is linked to performance, employees are motivated to work harder. Studies show that employees are increasingly driven by extrinsic rewards or financial incentives, such as bonuses and commissions.

• OTE helps boost sales and business growth: Employees work harder when their earnings are tied to sales results, leading to more business growth.

• A strong OTE plan attracts skilled workers and keeps them motivated: Top talent prefers OTE plans because they offer higher earning potential.

• Linking pay to performance helps control costs during busy or slow times: OTE helps companies adjust pay based on business needs, controlling costs during slow times and rewarding high performance during peak periods.

• OTE keeps employees focused on the company’s main goals: When pay is linked to company goals, employees work together toward shared success.

Challenges

• The pressure to meet goals may lead to unethical behavior: Strong pressure to meet targets can push some employees to cut corners or act unethically, damaging the company’s reputation.

• It's hard to set fair and achievable targets: Setting targets that are too easy or too difficult can hurt employee motivation. Many companies struggle with creating the right performance metrics.

• Too much focus on OTE can harm teamwork: OTE often rewards individual performance, which can discourage collaboration and reduce overall productivity.

• OTE compensation can create financial uncertainty for workers: Employees depending on commissions or bonuses may face financial stress during slow periods or downturns.

• Managing an OTE plan takes time and effort: Creating and managing OTE plans requires time and resources to track performance and calculate pay, which can be a challenge for HR teams.

Managing commissions and bonuses can be time-consuming. Compensation Planning Software simplifies this by centralizing compensation and equity plans, while standardizing performance formulas, data validation, and eligibility rules to reduce administrative work.

How to calculate OTE compensation

Calculating OTE compensation is straightforward. Remember the formula: On-target earnings (OTE) = annual base salary + annual commission earned at 100% quota attainment.

Here's how to do it right:

1. Step 1: Start with the base salary

   Determine the employee’s annual base salary, which is the fixed amount they earn regardless of performance. This is based on the role, experience, and market rates.

   For example, if an employee’s base salary is $50,000 per year, this figure will be used as the starting point for OTE calculation.

2. Step 2: Add the commission earned at 100% quota attainment

   Next, determine the commission the employee can earn by meeting performance targets (100% quota attainment). This is typically a percentage of the sales or revenue they generate and is outlined in the compensation plan.

   For example, if the employee earns a 10% commission on sales and is expected to generate $500,000 in sales, their commission would be: Commission = $500,000 × 10% = $50,000.

   Use Compensation Planning Software for easy commission calculations and planning. It simplifies monthly and quarterly commission calculations and generates commission statements to make incentive communications clearer.

3. Step 3: Combine these amounts to find the total on-target earnings

   Finally, add the annual base salary and the commission amount to get the total OTE compensation. Using the example above: OTE compensation = $50,000 + $50,000 = $100,000

   Here, the OTE for this employee would be $100,000 if they meet their performance targets.

OTE compensation examples

To give you a full understanding of OTE compensation, the scenarios below illustrate how it works for different roles:

1. Sales representative

   Sarah is one of the sales reps and a sales development representative at an electronics company. Her average rep earnings include a base salary of $40,000 per year. As a sales rep, she earns a 10% commission on the sales she generates.

   Over the year, Sarah meets her sales target of $500,000, earning a commission of $50,000 ($500,000 × 10%). Sarah’s sales OTE salary for the year is $90,000 ($40,000 base salary + $50,000 commission).

2. Account executive

   Emily works as an account executive on the sales team with a base salary of $70,000. She earns a 12% commission on all the sales she brings in throughout the sales cycle. Throughout the year, Emily exceeds her target by closing $600,000 in sales. Her commission amounts to $72,000 ($600,000 × 12%).

   Emily’s annual OTE salary is $142,000 ($70,000 base salary + $72,000 commission).

3. Real estate agent

   Mark is a real estate agent with a base salary of $25,000 a year. His pay mix includes a 6% commission on the sales of properties he closes. Over the course of the year, Mark sells $2,000,000 worth of real estate, earning a commission of $120,000 ($2,000,000 × 6%).

   So, Mark’s OTE for the year is $145,000 ($25,000 base salary + $120,000 commission).

Calculating OTE compensation is easy: simply add the base salary and commission. For simpler commission management, use Compensation Planning Software. It combines compensation, sales, and rewards in one system, with an employee portal for easy communication and digital processing.