Tiered Commission Structures Explained
The tiered commission structure is put into play when a company feels that the flat rate plan is not driving the desired performance, and wants to reward reps who over-perform. To higher levels of performance, they will offer commission plans that pay a higher amount for each tier of performance achievement. Note that this is often tied to setting a quota. (Download our guide, “Designing Sales Compensation Plans,” for tips on how to structure your plans.)
While the most basic incentive plan, the flat rate X% or $X on every deal, is easy to administer, easy to communicate, and easy to understand, it pays commissions at the same rate for all items sold, typically as a flat percent of revenue or profit. A variation is one that pays a flat amount, rather than a rate. This is used when the price does not change with each deal. This is best for firms who are not yet setting specific sales goals for the team (i.e. quota) and want to make every deal worth the same to the sales rep. Again, though, flat rate or flat amount plans don’t reward over-performance.
Thus, tiered commission plans are often initiated when a company wants their reps to make more per deal once they hit their quota, to encourage the sales team to meet, and even better, surpass the quota goal. To make this extra level of effort enticing, the payout rates increase based on easily understood levels of measured achievement. The plan now provides an incentive to the sales rep to not only hit a goal, but to also keep going so that they can earn the higher payout rates.
Download our guide, "Designing Sales Compensation Plans," for tips on how to structure your plans. Or, keep reading for more on tiered commission structures.
The plans are easy to white board: Set a quota, and then assign a higher payout for every deal brought in once quota is met. Make sure that the higher payout is still profitable for the firm, or you might drive achievement that puts the company under.
This specific plan design allows for additional payout tiers as well. For example, there could be three tiers of commission rates:
- One rate for below quota
- A rate when above quota
- A third rate for significant over-achievement (e.g. >200% of quota)
The tier measurement can be based on number of deals, number of units, total revenue, total profits, new customers, or other easily measured, calculated and communicated goals. A few companies go so far as to offer the higher rate for every deal closed, going back to the first one of the year (often called a “back to dollar one” rule, or retroactive payout rule). This can create a lottery moment for the sales rep. Most plans pay the higher rate for each marginal addition to performance, and not back to the first deal.
The tiered commission structure gives the sales rep a series of goals to focus on, and an incentive to keep producing deals once higher achievements are made. (Learn more about other commission structures.)
But what happens when only a few achieve the top tier? They set the example for the rest of the team:
“A wise man ought always to follow the paths beaten by great men, and to imitate those who have been supreme, so that if his ability does not equal theirs, at least it will savour of it. Let him act like the clever archers who, designing to hit the mark which yet appears too far distant, and knowing the limits to which the strength of their bow attains, take aim much higher than the mark, not to reach by their strength or arrow to so great a height, but to be able with the aid of so high an aim to hit the mark they wish to reach.” The Prince, Niccolo Machiavelli
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.