A Tale of Four Sales Commission Structures: Which One is Best?
What is Sales Commission Structure?
Sales commission – in concept, it seems simple enough. It’s the variable component of a total sales compensation package (base pay + incentives) based on a sales rep’s individual goals and performance. What makes it tricky is how that variable piece is structured. The most common and simple approach is basing variable pay as a percentage of a single sale’s revenue. If a widget sells for $1,000 with a sales commission rate of 5%, a rep would collect $50 for each widget they sell. But when deciding between different sales commission structures, is it really the best? Not necessarily.
Typical Sales Commission Structure Examples
The above revenue commission structure works well in situations where pricing is fixed, but again, it also greatly depends on the goals of the business. For example, if a company is trying to gain market share, enter a new market, or even block competitors from earning the sale, they might be less concerned with profits and would prefer the revenue plan. But quite often, this kind of structure does not align with the larger goals of the organization or the unique make-up of the sales team.
Download our guide, "Designing Sales Compensation Plans," for tips on how to structure your comp plans. Or, keep reading for more on commission structures.
As such, it’s beneficial to have various sales commissions structures that support the unique skills and abilities of a sales team and can motivate them to strive for the greatest financial reward. Knowing the pros and cons of the different types of sales commission structures – and choosing the right one – can lead to more fruitful results for each sales team member, as well as 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, though, involves both the price of the sale and the costs associated with making that sale, to arrive at the profit of each transaction.
In this scenario, if the company is selling widgets for $1,000, and there is $500 in associated costs, then the commission would be a percentage based on the remaining $500 profit.
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? If a company is only focused on making the sale, there might not be any resulting bottom line benefit, or even worse, there could be a negative impact if the selling price is too low.
Tiered Commission Plans
Tiered commissions are designed so employees can earn greater commission rates once they surpass a certain level of revenues. For instance, if a reps is earning 5% on each widget sold up to $100,000 in total revenue, the tiered commission plan might allow for the rate to increase to 7% once they surpass the $100,000 mark.
With this type of commission structure, high performers have additional motivation to keep selling, and thus, could even branch out into areas they wouldn’t have otherwise considered, such as upselling new features, etc.
The multiplier plan helps companies build custom-made comp strategies, but it can be a tedious process. Multiplier plans are good when sales leads want to implement multiple performance measures to a rep’s incentive plan. It can start with the common method of basing variable pay as a percentage of a single revenue, but then multiplying it by a percentage factor of quota achievement. Using multipliers can not only help reflect the sales cycle but also fine-tune how sales reps can stay motivated.
The Bottom Line
When it comes to sales commission structure, the story is never black and white. There are a number of other terms and ideas with which you should also be familiar.
For instance, the “draw against commission” is essentially a payment advancement that is subtracted from the final commission result. If the received draw is $200, and you sell eight $1,000 widgets at 5% commission (for a total commission of $400), you would be paid $200 because you already received the first $200 at the beginning of the month.
These three scenarios only scratch the surface on the different kinds of commission plan structures that can be considered. The long and the short is that one plan doesn’t fit all and the most successful organizations are implementing a hybrid mix of these plans to map both to their own corporate objectives, as well as to inspire the best performance from their sales reps and teams.
Designing Sales Compensation Plans
With careful consideration and strategic design, you can use incentive compensation to inspire your teams and empower them to perform above and beyond the competition.