No matter the market or industry your business falls into, it can certainly be challenging to figure out which type of incentive compensation plan aligns best with your company goals. In addition to aligning with corporate objectives, your plan must also be data-driven, and be built to ensure reps go the extra mile. While there are a multitude of ways you can make sure you hit your numbers, one of the most tried-and-true routes to go down is designing an effective sales commission structure.
Traditional sales commission plans are made up of two main parts: fixed base salary and variable compensation. Base salaries are designed to pay a fixed amount and are fairly straightforward. Sales commission structures—another key component in your incentive plan—are uniquely based on a salesperson's individual goals and performance.
Using sales commissions as a part of your compensation plan allows for different configurations based on the given sales solution. Because of their variable nature, they can be a strong tool to motivate performance throughout your sales team.
What is a Sales Commission Structure?
The most commonly used sales commission structure is using variable pay as a percentage of a single sale’s revenue. For example, say your company sells widgets. A specific widget sells for $1,000 with a sales commission rate of 5 percent, and your reps would collect $50 for each widget they sell.
However, there are several ways to structure your commission plan. To help you decide which is best for your company, we’re breaking down the most common sales incentive compensation models.
Sales Commission Structures Examples
There are many ways to build out your sales commission structure. Standard sales commission structures typically include revenue, gross margin, and tiered commission structures, along with multiplier and commission-only plans.
Our previous widget example demonstrates a revenue commission model, aka one of the most popular sales incentive structures. It works well in situations where product and service pricing is fixed—but greatly influences the success of your business.
For example, imagine a company is trying to increase share in their industry, enter new markets, or outperform competitors. They might prefer the revenue plan that encourages sales reps to close deals. However, this setup often fails to align with larger organizational goals or the unique makeup of the sales team.
Because of this, it’s important to consider the responsibilities of each sales role and develop sales commissions models that are tailored to each role on your sales team. Knowing the pros and cons of the different sales pay structures boosts sales performance and grows the company’s bottom line. Here are a few other options to consider.
Gross Margin Commission Plans
Anything based on revenue only has to do with the price tag of the sale. Gross margin sales commission structures, however, consider the profit of each transaction, including the price of sale and the costs associated with making that sale.
Let’s consider our commission pay example again—a company sells widgets for $1,000, with $500 in associated costs. The commission is a percentage based on the remaining $500 profit, rather than the $1,000 revenue.
When it comes to gross profit margin vs. revenue commission, the main argument for gross margin is that each sale should benefit the company’s bottom line. That’s the name of the game, right? Companies focused purely on making the sale, risk having little impact on the bottom line, or worse, having a negative impact if the selling price is too low.
Tiered Commission Plans
Tiered commission plans are designed so that employees can earn greater commission rates as they surpass certain levels of revenues. For example, imagine a rep earns 5 percent on each widget sold up to $100,000 in total revenue. A tiered commission plan might allow for the rate to increase to 7 percent once the rep surpasses $100,000 in total sales. The commission rate may increase again at increased total sale amounts.
This type of commission structure helps boost sales team morale. High performing reps have additional motivation to continue selling and earn higher commission rates. Thus, this encourages sales reps to branch out into areas and chase opportunities they might have otherwise overlooked.
Multiplier Commission Plans
The multiplier commission plan helps companies build custom-made compensation strategies, but it can be a tedious process to design and implement. Multiplier plans are beneficial when sales leaders want to use multiple performance measures in a rep’s incentive plan.
The multiplier commission plan starts with the typical sales commission structure, but then it's multiplied by a percentage factor of quota achievement. Using multipliers can not only help reflect the sales cycle but also help motivate sales reps to over-perform.
Straight Commission or Commission-Only Plans
Straight commission plans refer to paying reps on a commission-only model, with earnings made up entirely of variable pay (thus, there is no fixed salary component). Some argue that the straight commission plans aren't necessarily a specific sales compensation structure. However, it's important to address what it means to be commission-only.
Under a commission-only plan, sales reps are extremely motivated to close their deals, but on the other hand, their work also comes with more stress given the amount of risk involved, which can increase the chances of sales burnout.
This also increases the chance that sales close in a manner that doesn't align with company goals. That said, there are certain situations where commission-only structures make the most sense, such as shorter sales cycles or when there is an opportunity for sizable commissions, etc.
The Bottom Line
When it comes to the types of commission structures for sales reps and how to develop strong compensation plans, the process is never black and white. There are a number of other terms and ideas you should also be familiar with.
For example, “draw against commission” is essentially a payment advancement that is subtracted from the final commission result. Imagine a sales rep received a draw of $200 and sells eight $1,000 widgets at 5 percent commission (for a total commission of $400). The rep earns $200 in commission because they already received the first $200 at the beginning of the month.
In reality, one plan design doesn’t fit all, and the most successful organizations are implementing a hybrid mix of these sales commission structures to map their own corporate objectives and to inspire the best performance from their sales reps and teams.
Sales Commission Reporting
A solid sales commission structure/plan drives reps to perform and sell in a certain manner. Fortunately, it also provides a structure for reporting and serves to calculate commissions and more. All things considered, it is more than just creating your compensation plans. When built correctly, your entire commission structure allows sales leaders to easily manage and make adjustments as needed.
Xactly SimplyComp arms companies with increased visibility into their sales performance data, allowing reps to see earned commissions in real-time. SimplyComp is an easy way to leverage incentive compensation to accelerate performance. It automates sales commission reporting, increases data accuracy, and helps you to easily spot commission errors and reduce disputes. Start your free trial of SimplyComp today.