Do you feel your sales representatives are not doing their best for your company?
If this is the case, you may need to incentivize them by giving the appropriate sales commission for the purchases they make. Sales commissions are a time-tested method to instill a sense of ownership and motivation within the sales representatives by building a connection between hard work and its rewards.
It has proven to be an effective method for generating more sales at a lower net expenditure for businesses. At the same time, salespeople get higher earnings and feel more rewarded for their work. In fact, most growing and established companies offer 20-30% sales commissions on an average over the base salary to make their sales reps more motivated and productive.
So, it’s time you apply the right plan for commission payment, or commission structure, to your company. And this blog will help you start by covering sales commissions and their structures in detail. Also, keep reading till the end to find out how to select and apply the best commission structure for your business.
Table of Contents
Sales commission is the amount of money a salesperson earns based on the number of sales they have made. It is a financial incentive to reward salespeople for bringing in more sales by paying them a certain percentage of every sale they make. You can classify commissions as variable expenses.
The next question is- How to calculate sales commission?
Typically, companies pay a decided percentage of the total sales revenue as commission. So, you can calculate the commission amount with this sales commission formula:
Commission = Total Sales Revenue x Commission Rate.
In most cases, salespeople earn this commission in addition to their regular salary. But a 100% commission model is also gaining popularity rapidly, where companies pay sales reps for each sale without any standard salary.
Sales commission is a fee paid to employees as a reward for their sales. You can calculate it as a defined percentage of every sale. So, the more the value and volume of sales the salespeople make for the company, the more they earn in commissions.
This incentive ensures that salespersons get fair rewards and feel motivated to work harder, generating more sales for the company. It’s a win-win deal for both the business and its sales representatives!
Companies usually define commissions within a commission structure, which is a plan that outlines how much an organization will pay its salespeople for every sale. This structure varies as per the specific business and the market in which it operates.
Commission structures are common in large industries, such as retail, real estate, insurance, and the stock market. You may also apply them for direct sale products or services that are offerings sold directly to a customer without a storefront.
However, there are several types of sales commission structures. And you must understand your options clearly to find the one that suits you best. So, let us discuss the major commission structures and their ideal use cases-
The base salary plus commission plan is amongst the most conventional commission structures. Salespeople get a base salary with a pre-decided commission. The standard salary to commission ratio followed in Base Salary Plus Commission channel is 60:40, where 60% is fixed, and 40% is variable (commission).
This structure is best for companies where sales rep retention is vital for the sales organization’s success. This is the case of companies actively investing in the success of their representatives by incentivizing their performance.
With the straight commission plan, the income of sales reps comes directly from the sales that they make. There is no base salary paid regularly.
So, high-performing sales reps typically thrive in this plan by maximizing sales. But the structure is not very stable and may not interest salespersons looking for job security.
This structure is ideal for startups or small businesses that lack reliable capital and want to make payments only after getting revenue. It amounts to a pay-as-you-go plan that suits businesses with insufficient resources to provide high base salaries.
In a relative commission plan, the commission a representative earns is directly proportional to how much of the pre-set quota they achieve. That compensation comes in addition to the base salary, providing reps with more income security than a straight commission plan.
This compensation plan is a more secure alternative to a straight commission plan. The commission is still directly tied to performance. But it doesn’t leave behind reps that might be running into trouble due to justified causes. So, it is best for medium to large companies who wish to find and retain advanced talent.
An absolute commission plan pays representatives for hitting predefined goals and performing specific activities, like selling a set number of particular products or acquiring new customers. Similar to a relative commission plan, an absolute commission structure for sales helps incentivize low performers. However, the focus is less on the sales revenue and more on activity.
This compensation plan is employed by objective-driven businesses to help direct the focus of sales reps and achieve specific targets. An absolute commission plan may be the best fit if a business needs to improve its numbers related to a particular activity.
A straight-line commission plan rewards the salespeople based on the amount they sell. In this model, the commissions are directly proportional to the amount sold, even meeting the defined quota. So, businesses can incentivize underperformers to meet their quota without slowing overperformers down.
Straight-line commission plans are best for more established companies that want to incentivize representatives to reach their full potential. They must also have the resources to accommodate an uncapped commission structure.
A tiered or multiplier commission structure encourages reps to put in their best effort by providing higher commission as they hit larger sales milestones. Here, reps are paid increasing commissions as they meet and exceed defined tiers in their quota by closing more deals than their basic expectations.
A tiered commission plan is lucrative for organizations with salespeople with average performance. It encourages better prioritization of deals and constant effort to achieve higher levels in the quota tiers for an exponential earning boost. And this makes it ideal for fast-growing companies who need highly motivated salespersons.
Here’s a sales commission policy sample:
If a rep sells a unit that gets 30 percent of quota, the commission would be 2%, but a sale that achieves 50 percent of quota will yield 10% commission!
In this structure, salespeople work with clients in clearly defined regions and get payment on a territory-wide, team-oriented basis rather than a commission on individual sales.
A territory volume commission plan suits businesses that have their presence in multiple territories. Moreover, it is ideal for team-based organizations who want to niche down in specific service areas and prioritize their territories.
With a recoverable draw against the commission plan, the sales representatives receive their commission at the beginning of a payment or sales period. It is an advance payment made in the form of a predetermined lump sum per the employment contract. That lump sum or “draw” is subtracted from that rep’s total earned commissions at the end of the sales period based on the performance.
Recoverable draw against commission plans boosts the performance of newly hired sales representatives or reps who are getting adjusted to a new territory. You may use it to ensure sustainable training and improvement costs by allowing recovers of commission.
A non-recoverable draw is a fully guaranteed commission stipend. It also starts with a firm giving its reps a predefined lump sum per the employment contract. But representatives are not expected to pay any of that money back.
This sales commission agreement is not sustainable or motivating but may be used by larger firms as a short-term measure during times of uncertainty to ensure that their sales reps have a stable income source.
This structure is based on the long-term value of individual accounts, where salespeople act partly as account executives. Salespeople who close deals continue to receive a commission from those accounts as long as they generate revenue.
This commission plan can ensure higher income and motivation for salespeople who will try to build long-term relationships that continue to benefit the company. But commissions may also take a hit due to conditions out of the rep’s control.
This structure best suits businesses that want to maintain long-term relationships with clients. And this typically includes entities like B2B companies, advertising agencies, or consulting firms who look to hold on to high-paying clients.
The gross margin structure is a simple sales representative commission structure that operates similarly to the baseline plus commission structure. However, it considers each transaction’s gross margin instead of the sale’s total revenue. In other words, this structure considers the profits instead of revenue by subtracting the price of the sale and related costs from the sales revenue before finding the commission.
So, you will calculate each rep’s commission on the profit rather than the total amount of the sales made in this structure. The gross margin commission structure helps ensure bottom-line profitability while motivating reps to secure the most profitable deals.
Growing businesses aimed at maximizing profits may find this sales commission agreement beneficial, as it also ensures lower expenses instead of focusing solely on the revenue.
Let’s take a sales commission policy sample:
If you sell a product for $110,000, and there are $10,000 associated expenses with that specific sale, your company would earn a $100,000 profit on that deal. And based on a 10 percent commission rate, a rep would earn $10,000 as commission calculated as 10% of 100,000.
The correct commission structure for sales ensures that salespersons get compensated fairly and their hard work is sufficiently rewarded. At the same time, it helps you stay in line with your budget while paying only for the revenue achieved.
The right structure ensures that your salespersons are motivated while boosting your company’s profitability and sales operation sustainability. Moreover, the right balance between salary and commission helps you attract and retain the best sales force for your company.
So, you must select the proper commission structure or decide on a hybrid structure that perfectly matches your needs. And this decision should be based on all involved resources and market factors like available budget, offering type and value, business scale, employee expectations, and average industry commissions.
Sales associates who feel you are paying them reasonably and sufficiently are more likely to stay with your company rather than leave for better opportunities. However, you can’t just go on raising commissions to attract and retain talent!
You must balance the commission rate with the revenue amount, base salary, and your budget. So, here are some factors you must consider while choosing the correct commission rate-
The competition to onboard the best talent is growing across industries. As a result, salespeople are looking for the highest commissions for their effort. Hence, you must offer a competitive commission to attract good talent. And this involves checking the average standards for your industry and making an offer similar to or above it.
The ideal sales representative commission varies across the levels of professionals in sales teams as their responsibilities and targets vary. For example, the sales manager manages the entire team continuously and would get a higher commission rate than the per-sale commissions of individual salespeople. Moreover, the sales manager commission structure is based on the entire team’s performance, not individual sales.
Incentives will keep your sales teams excited and motivated. However, commissions based on complex calculations can leave them confused! So, you must design the commission structure to be easily understandable for the salespeople.
Businesses function in diverse ways across industries. So, you must focus on the resources and requirements of your specific company to decide on the correct commission.
For example, the commission model for B2C companies may include a constant rate paid for each sale. But a B2B business’s commission is usually calculated per deal based on the category of the partner, the deal size, and the extent to which the partner adds value to the business.
The value of the offerings often affects the commission rates. This is because completing the sale of high-priced goods is generally better rewarded than low-value deals. Expensive products (especially B2B) that are sold infrequently but offer high revenue may involve a higher commission. Meanwhile, low-value sales may offer a lower and constant commission rate.
The profits define the limits within which you can spend on commissions. Spending a part of the revenue on commissions will undoubtedly help to motivate your sales representatives and improve their sales. But spending most of your revenue on commissions will greatly reduce your profits for each sale!
So, you must analyze the revenue generated and decide the profit margin required for your business to be sustainable. Then, you must plan a commission rate accordingly to ensure the right balance between profit margins and commission that motivates your salespersons. This will maximize your profitability, creating a win-win situation for your organization and its sales representatives.
A fair commission rate for sales is subjective and varies based on your business’s niche, offerings, specific employee roles, and market conditions. However, referencing your industry’s average commission rates can give you a reliable idea of a fair rate. And paying a similar or better commission rate will ensure that you can attract and retain more talent while maximizing its potential.
So, here are the average sales commission rates for all key industries-
Sectors that use independent contractors may also implement a 100% commission pay structure.
As we saw in this blog post, there’s no single best solution for every organization regarding the best sales commission structure, and you must understand every option in detail to find what works for you!
So, we covered the topic comprehensively to help you narrow down your options and quickly find the perfect match. However, you must ensure that your sales process is up and working before you can plan or implement a commission structure.
This is because you can create a much fairer and more accurate commission structure once your sales activities and metrics are clearly defined. You may still need to experiment with your structure to find the right balance at the start. But your sales will surely boom once the suitable commission model clicks into your sales process.
All the best!
Sales commission is the financial incentive that a company gives to a salesperson based on the number of sales they have made. It is usually a certain percentage of every deal they close.
Ideally, it is better to pay sales commission for the sales made along with the salesperson’s paycheck. However, some organizations even pay commission quarterly or yearly.
A good sales commission, on average, is between 20 to 30 percent, while it can be even as high as 40-50 percent. However, it depends on the technical ability of the salesperson and their compensation plan.
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