The sales commission structure of your company impacts a lot more than just the profitability of your sales team. How you pay your sales team can either overshadow or help improve the morale of your employees, which can not only attract but also retain top talent.
But sales commission structures can be difficult to choose. There are many factors that go into the decision-making process, and it is important to understand each of them to make the right choice for your business. This article will do just that.
What Is a Sales Commission Structure?
A sales commission structure is a type of compensation plan that is used by companies to pay their salespeople. This usually includes commissions, bonuses, and other incentives on top of base salary. If sales commission is the variable component of a total sales compensation package, then the sales commission structure defines to what extent sales commission can vary.
A hypothetical commission structure might be one where a salesperson earns 20% of the revenue generated from the sale. This means that if they sell $100,000 worth of products during their time with the company, they will get $20,000 in commission payments.
Why it’s Important to Choose the Right Sales Commission Structure
Many businesses have found the absence of a well-defined and well-thought commission damaging to their bottom line. They have been guilty of committing some major wrongs. For instance, they focused on the amount of time their salespersons spent working instead of measuring their performance metrics. They soon realized that this tightrope-walking approach doesn’t serve them well, and so they changed their commission structures to motivate better performance.
The ultimate goal of any salesperson is to find a way to earn more. This is the reasoning behind finding a sales commission structure that offers an on-target earning (OTE), but it’s still up to each salesperson how much they earn. A salesperson’s performance is directly linked to the amount of money they will earn, so it’s no secret that a well-structured commission plan is an excellent way to encourage top performance because accountability produces results.
Having the right sales commission structure ultimately will:
Provide a strong incentive. It motivates salespeople to close as many deals as possible by increasing their productivity and decreasing their time-to-close.
Attract top talent. Talent is hard to come by. Having the right commission structure helps attract top talent because there is more financial security.
Increases efficiency of the sales team. Having a good commission structure based on how effective each individual is at selling assists companies in increasing their efficiency by having more accurate results in less time.
Higher sales conversion rates. A properly structured sales commission plan incentivizes salespersons to take the necessary steps that lead to higher conversions.
Reduce employee turnover rates. The key to a low-turnover and high-performance sales force is having the right sales commission structure. Having an effective commission structure, which includes a high base salary and a performance incentive, can be one of the most powerful tools in promoting employee loyalty.
What are the different sales commission structures?
The importance of adopting the appropriate sales commission structures should be evident by now.
To thrive in a competitive market, it's vital to keep up with the latest trends. This includes adopting the appropriate sales commission structures. If you're not familiar with how your company's commission structure is organized, it might be time to take a closer look.
Sales commission structures vary from company to company and are usually dependent on the product that is being sold. A real estate agent might charge a percentage of the sale price, whereas a small business owner might sell a product for a flat fee. With so many types of sales commission structures, it can be difficult to determine which is the best for a business.
For those unfamiliar with different sales commission structures, here are the ten most commonly used sales commission structures:
1. Base pay compensation
The idea is to pay salespeople a set amount of money for the amount of work they put in, instead of paying commissions on every sale. They are paid a flat-hourly rate regardless of how many deals they are closing.
This compensation structure may not push them in to working longer hours, or in improving their productivity and performance. There is also nothing motivating or incentivizing the team members as a whole, and promotions or bonuses for targets reached or even for a job well done. When a top performer and the lower performer earn the same, it essentially kills any motivation to do well. Their desire starts to circle around just getting through the day, rather than having their clients walk away with the business.
Pay is on an hourly basis.
Companies in underdeveloped and developing economies may also prefer to pay per-day.
2. Basic commission
This is a step up from base pay compensation. Companies pay salespeople base salaries on a flat hourly rate along with a percentage of sales they make. When they make a sale, they earn a commission. There are usually no monthly targets in place, and a commission on the sale is the only variable component of their compensation.
Companies may be able to afford to pay an hourly rate in addition to commission because their revenue is high enough. This system places different levels of responsibility on both parties, which can lead to a better and more productive relationship.
A basic commission package helps in understanding expectations for each salesperson easily and keeping them motivated for their work, as well as helping them understand their work better. It also gives a credible idea of how well someone has performed in their job and what they are worth. It helps in setting goals for each individual.
However, a basic compensation package may not be as effective in terms of motivating salespeople to sell more. The incentives to perform aren’t good enough, as salespeople have no targets to chase. There is also no room for personal growth. Not only that, but the salespeople may not be as invested in maximizing their company’s revenues if they don’t feel they can be part of their growth story.
A flat hourly pay + percentage of every sale that they make.
3. Multiplier Commission
Multiplier commission structure starts with a basic revenue commission percentage. This percentage is multiplied by an agreed-upon figure based on a salesperson’s quota achievement. A multiplier plan gives reps the opportunity to earn more money as they progress in their sales career. Several companies find this an affordable way to drive customer acquisition and sales.
This sales commission structure works well for incentivizing sales reps to sell more and earn more money. But it can be difficult to implement, especially for companies that are new to multiplier sales commission structures. Not only are they difficult to set up, but they also require constant monitoring and tweaking to get it right.
Multiplier commission structures allow businesses to offer different levels of compensation for different levels of performance, in a way similar to how salary ranges are typically determined. This ensures that all the salespeople are evaluated on the same set of standards, with a focus on core values and performance.
There are some downsides, though.
A salesperson may not fully understand what exactly their commission is and how the compensation plan works. This lack of clarity can cause a lot of frustration for those who want to know what they will be earning daily. The multiplier commission structure can make it harder for salespeople to track their performance and leads, especially if they are not in charge of their territory or do not have a dedicated manager. But companies can fix both this by clearly spelling out the commission structure, leaving no room for doubt or confusion.
A sales rep earns a standard 10% commission.
If they attain 90% of the quota, a multiplier of 0.9 is applied to their standard commission. Their revised commission would be 9%, and so on.
75% of the quota: standard commission x 0.8 multiplier = 8% commission.
50% of the quota: standard commission x 0.6 multiplier = 6% commission.
40% of the quota and under: standard commission x 0.4 multiplier = 4% commission.
4. Tiered Commission
There is a lot of pressure on sales reps to close more deals, and the best way to motivate them is with a commission structure that rewards top performers. Tiered commission structures are a popular option, especially among companies in the B2B space.
Companies set tiers based on number of units sold or the total revenue generation. Commission is determined by the level of success a salesperson has achieved. Their success could be measured in number of sales they've closed, number of opportunities they've won, and other similar metrics. The further one progresses in their career, the more money they make.
Tiered commission structures are great for businesses that want to scale up their sales department and encourage its sales teams to perform better. The more customers that a rep brings in, the higher the commission. This structure encourages sales reps to explore new revenue channels such as upsells and cross-selling because they will become more profitable as the number of customers they bring in increases.
Adopting tiered commission structures for sales reps provides a variety of benefits to both the company and the employee. Providing incentives and bonuses for reaching certain milestones can inspire an employee to work harder, while the company can retain talent by offering a competitive salary.
However, there is one significant drawback. The pay is based on a percentage of gross revenue. So, this system could be beneficial for an individual with a large volume of sales, but it might result in a lower total salary for an individual who does not perform as well at generating sales.
In terms of units sold, an example of this model would be a 4% commission on the first 1,000 units sold, and 5% on each additional 1,000 units sold, and 6% on every additional 1,000 units sold after that.
In terms of total revenue generated, sales reps may earn a commission of 4% on all products sold when the total revenue generated by them reaches $5,000, 7% when the total revenue reaches $10,000, and 10% when total revenue generated exceeds $15,000.
5. Residual commission
A residual commission structure is most common in organizations operating on high-budget, long-term accounts, such as investment banks, consulting firms and insurance companies. Customers have an ongoing relationship with the company, which can be reasonably expected to continue for some length of time. This also means that the number of commissions generated is quite high.
In a traditional sales model, the seller is incentivized to sell as much as possible. Under this model, sales reps receive commission as long as the accounts they generate continue creating revenue. Because this sales commission structure practically incentivizes sales reps to continue building positive relationships with customers beyond the initial contract signing, this encourages them to offer a more personalized and consistent experience for customers.
This model is a more sustainable way to grow and scale your business with minimal risk of failing. It’s a win-win commission structure in that it ensures that sales reps do their best to retain customers to maximize their commissions, while the company benefits from increased revenues.
A client signs up with a company for $5,000 for its services. If the commission is set at 6%, the sales rep who brought the client on board will continue to receive $300 commission for as long as the client keeps paying the company.
If a sales rep retains 50 of such clients over time, they earn commissions of $15,000 every month.
6. Commission Draw
The commission draw model is a new approach to wage-based compensation. It has three main parts: base pay, commission, and bonus. In this model, salespeople are paid as a mixture of base pay and commissions. Commission rates are usually higher than top-down models like the commission-only structure or the base pay plus commission structure.
When a sales rep is not making enough money on commissions, it can be a huge blow to their motivation. With the commission draw structure, sales reps are promised a certain amount of money each month regardless of the number of sales they generate for their company. This ensures that the company is not missing out on any potential sales, and it can be seen as a reliable way to keep people motivated.
Commission draw sales commission structure is typically used for new hires. It allows a company to keep the same commission structure that they have been working with. Companies can get their newly recruited sales reps to speed up on the business quickly while still giving them the opportunity to build their salary in the first year.
If a company has a draw amount of $5,000 and if a sales rep earns a commission of $4,000, they keep their full commission along with the difference between the draw amount and their earned commission — in this case, $1,000. The sales rep would still earn $5,000. Some companies also stack on bonuses to motivate them further.
7. Territorial volume commission
Sales teams typically have a hard time building a spirit of cooperation and teamwork. They have to rely on individual personality, which often leads to conflict. The territorial volume commission structure is designed to build trust and unity in sales teams by keeping the focus on collaboration and results.
Under territorial volume sales commission structure, the sales generated within a territory are added up, and the commissions earned are divided equally among all sales reps working within that territory.
It fosters a team-first environment and collaboration, which is conducive to success. It provides motivation to work as a unit rather than attack goals individually, which can push employees to reach new levels of productivity and efficiency.
However, keep in mind that adopting this commission structure may leave top performers disgruntled with the lack of proper recognition — especially when they are straddled low or below-average performances in the same team.
The sales target for four sales reps working the same territory is $100,000. One rep brings in $30,000 in revenues, two reps bring in $25,000, and the fourth rep brings in $20,000.
If the territorial commission rate is 30%, the commission gets split equally and they each earn the same commission of $7,500.
8. Revenue commission
Revenue commission sales structures get their salespeople to sell their products or services by paying a percentage of the total sales price. This can be seen as a type of revenue sharing, where the company pays the commission to the salespeople who make money from the sale.
In a traditional commission structure, sales agents get a salary, be it hourly or weekly. In contrast, sales agents in a revenue-based commission structure only get paid on their revenues. How much salespeople sell determines how much they earn. It’s simple to understand and execute for reps and company leaders alike, and paying sales reps based on the revenue they bring in ensures that top sales performers are also the highest paid.
Many companies use this method when they want to grow their market share or enter new territories. They’re not as focused on profit as they are on larger business goals.
If a sales rep brings in $50,000 total revenue in a month and if their commission rate is set at $10, they will receive $5,000 as compensation that month.
9. Gross margin commission
A gross margin is the overall profit of a company after all its costs have been subtracted. This is typically calculated by taking a company's total revenues and dividing it by its total products sold. A gross margin sales commission structure is when certain sales reps are given a flat percentage on each sale they make that is then divided among all the other salespeople.
Gross margin commission structures incentivize reps to drive sales. The difference is that a sales rep’s commission is calculated using the gross revenue each sale generates, rather than the revenue that each sale generates. This sales commission structure evaluates a product’s sale price and the costs associated with closing a deal to calculate actual profit. Sales reps then earn a commission based on this actual profit.
It is one of the most effective commission structures to help align sales and marketing. It ensures that every sale supports the company's bottom line, and that every rep who relies on discounting to close deals has less of an incentive to do so.
If the price of a product is $100, but it costs a company $25 to get the product into the customer’s hands, sales reps earn a commission on the profit ($75) and not the actual price of the product ($100).
10. Straight commissions
In straight commission structures, a company pays a set amount of money to the salesman for every sale he makes. This type of commission structure is typically used when a salesperson is not required to share their sales with their team members, or if they are paid by the hour.
With low investment and a focused sales strategy, this commission provides startups with the opportunity to quickly gain market share and expand their reach. For established companies, this option makes sense as well. The smaller the company, the more room there is to grow. It increases revenue for both the seller and customer because it is not very complicated and does not require any additional effort from either party.
However, this sales commission structure turn a few salespersons greedy, and they may not allow customers to feel like they are getting a good deal. This may lead to plenty of unhappy customers and may reduce customer retention.
If a sales rep sells a product at $1000 and if their commission rate is set at 10%, they will receive $100 from each sale.
Which sales commission structure is best?
Different commission structures are available depending on the type of salesperson and the company.
Companies such as Amazon, Uber, and Airbnb have a straight commission structure. The commission is paid out according to how much revenue you make. In contrast, companies like Nike and Apple have a variable commission structure. The commission is paid out according to how much of your quota you sell at the end of the day or week. Variable commissions provide more flexibility for salespeople to earn bonuses or incentives if they meet certain targets.
To see which sales commission structure works best:
Understand your target market.
What is the cost of your product or service?
What is your target market?
How much do you need to sell to make a profit?
What is the cost of the sale?
What is the size of the sale?
Are there any risks involved in selling a product or service?
Is the compensation fair?
Will the compensation motivate sales teams to work well?
Will the commission structure let you have a healthy profit margin?
The choice of sales commission structure can make or break your company. In most businesses, the goal is to maximize profit and minimize expenses. With the right sales commission structure, it's possible for companies to reap both benefits. The sales commission structure is all around the corner and the future of sales. The key to success in this future is to invest in salespeople and make them feel like they are part of the company, not just on the outside looking in.
The first step is to understand how commissions are paid out in your company. Next, you need to figure out what percentage of sales you want each individual on your team to generate. You should also consider whether you want your team members to share commissions with each other. Finally, you should think about how much money each person on your sales team should make in total and what percentage of that total they should make.