How to determine the best commission structure
The heart of sales performance is motivation. Salespeople often find closing deals without proper incentive becoming an uphill task. When a company gets motivation right, it is a win-win for them and the salespeople. Sales incentive compensation plays a major role in the salespeople's ability to drive revenue growth.
It is important to note that not all compensation is the same. Depending on an organization’s goals, salespeople's roles, and company products, a commission structure should be designed to drive performance effectively and efficiently. As the business grows, it can get difficult to know when and how best to scale.
To help you make the best decision on choosing a compensation plan, here is what you need to know about sales commission structures.
What is a Sales Commission Structure?
Traditionally, sales compensation is made up of two main parts: fixed and variable pay. Base salaries or as commonly known, retainers, are designed to pay a fixed amount and are fairly straightforward.
Sales commission structures are a component of sales variable pay, determine how sales reps will be paid, and indicate which behaviors salespeople will be rewarded for.
Using sales commissions as a part of your compensation plan allows the company to 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.
Types of Sales Commission Structures
1. Base Salary/retainer + Commissions
This structure involves a base salary that is relatively lower and adds a percentage of sales made as commissions. This structure is more lucrative than a commission-only structure as salespeople are able to build a rapport with a client as there is no rush to close the sales. Salespeople can also take time to do other roles unrelated to sales like building databases, attending team meetings, and answering emails/prospecting.
However, this model is risky as salespeople might not be driven as they know they will be paid even if they don’t close sales. Even though the model is viable long term, the company will incur losses in the initial months before the salespeople close sales.
But it works especially well for companies that have one core offering or that don’t have much variability between the items they sell. For example, a small software company that sells one primary product that’s roughly the same price for every customer.
2. Revenue Commission Structure
One of the simplest and most commonly used sales commission structures is variable pay as a percentage of a single sale’s revenue. Under this incentive structure, reps earn a flat percentage for every sale. For example, imagine your company sells a product for Kes. 100,000 with a commission rate of five percent. For each unit they sell, your reps would earn Kes. 5,000 in commissions.
This is commonly used in companies that have a singular product with fixed pricing, smaller teams, and companies with less complex products or services.
3. Gross Margin Commission Structure
This commission model operates similarly to the revenue structure, but it also considers the profit of each transaction, including the price of the sale and the costs associated with it.
However, under a gross margin commission structure, a rep’s commission will be calculated on the gross revenue generated, rather than the total amount of the sale. For example, if a product is sold at Kes. 100,000, let’s say the associated expenses are Kes. 10,000. The company recognizes a Kes. 90,000 profit on that deal. Based on the 5% commission rate, a salesperson will earn Kes. 4,500 (five percent of the Kes. 90,000).
This sales commission structure can help ensure bottom-line profitability while motivating sales reps in their bid to meet their sales quotas. It works well as you begin to grow your sales team and scale your business.
4. Tiered Commission Structure
This structure is designed to motivate sellers to continuously surpass certain levels of revenue sold. For example, imagine a sales rep earns five percent on each product sold up to Kes. 100,000 in total sales. In this structure, the rate might increase to seven percent once the rep surpasses the target of Kes. 100,000. This structure is very effective as it encourages reps to over-perform as their rewards increase the more they sell.
Tiered commission plans are a great next step in scaling your sales team and business. Because they are designed to promote over-performance, they can be extremely effective compensation models for driving revenue in larger, more established sales teams.
5. Draw-Against Commission
This commission structure acts as a "guarantee," paid with every sales paycheck. The draw is usually a predetermined amount that functions similarly to a loan or cash advance, which, depending on the incentive setup, reps may or may not be required to pay back. For example, a sales rep can be given an advance on their commissions, like Kes. 500. If they earn commissions of Kes. 2,000, then they can be paid Kes. 1,500 or the company writes it off.
This is mostly used when sales reps are new or in times of uncertainty. Draws can provide ramping reps additional income until they are able to work at full capacity, and they also offer stability when there are outside factors impacting business, such as economic or market disruptions.
6. Multiplier Commission Structures
The multiplier commission plan allows companies to build custom-made compensation strategies, but it can be a tedious process to design and implement. The multiplier commission plan starts with a basic revenue commission structure, but then it's multiplied by a percentage factor of quota achievement. To simplify it even more, think of this plan as a combination of a revenue commission structure and a tiered commission structure.
As per the table below, it is clear to see that depending on the salesperson’s progress to the target, their commission rate will change.
This structure will motivate sales reps to over-perform since they are aware that the commissions will change on extra effort and performance.
7. Straight Commission Structure
In this structure, there is no fixed salary/retainer component, and salespeople earn on variable pay only. This structure leaves sales reps motivated but is risky, as they could get a burnout.
This structure is not commonly used but will make sense to companies that have shorter or temporary roles. It can also work if the product's sale offers sizeable commissions.
Before determining the best structure, it is important to consider the following:
The company goals and objectives
How to motivate each role in the company based on their different responsibilities
How the incentives will drive the right behaviors
How the structure will motivate and encourage the teams to perform beyond their quotas
Based on the above considerations, the following best practices will help your organization find the right sales reps on factors like the industry the company operates in, geographical locations, salesperson role, benchmarking against industry data and tailoring incentives to sales roles in the organogram.