Traditionally, sales reps are paid a base salary plus a commission on whatever sales they manage to close. Depending on what industry and business you’re in, these commission structures can vary greatly. Some commission structures are better suited to certain businesses, but all directly affect the motivation of a sales team; whether it be positive or negative.
If you're in the process of picking the perfect sales commission structure, explore this guide to figure out which is best for your business.
What is a sales commission structure?
A sales commission structure is the variable element of a sales person's total compensation package. It's most commonly based on a sales rep's total output or performance goals being met. While the salary portion is fixed and fairly straightforward, the commission structure offers different configurations depending on the strategy and goals of the business.
The most common approach is basing variable pay as a percentage of a single sale. If you operate a retail clothing store for example, your sales reps would receive their hourly wage plus 3% of their total sales as commission. If they sell $1000 in one shift, they would receive a commission of $30. Every industry has an ideal sales commission structure, so which is best for yours?
What are some examples of sales commission structures?
Revenue Commission Model
The revenue model was discussed in the previous example and is the most common commission set up. It typically works best in businesses with fixed pricing structures because it's predictable. But some argue that this model is unintentionally short sighted.
If a company is trying to gain market share, enter a new market or even block competitors from earning sales, this model works. It encourages sales reps to focus on the sale but overlooks long term growth of the entire sales infrastructure. Even if the business is not seeing profits, the sales reps still make a commission.
Gross Margin Commission Plans
Gross margin differs from the revenue model because it takes into account the cost of making a sale.
Let's say you're selling widgets for $1000 and it costs you $400 to make the sale (this includes overhead, insurance, product, etc.). According to the gross margin plan, the commission would then be a percentage based on the $600 the business received.
While it may seem like less in a sales rep's pocket than the revenue model, this commission structure takes into account the business's bottom line. If the business is solely concerned about making a sale, there may not be any bottom line left to profit from.
Hybrid or Tiered Commission Plans
Hybrid or tiered commission is based on reaching specific sales revenue targets -- each with greater commission rates. It combines the previous two models by covering the bottom line first and then adds additional incentives to sell more.
If the sales reps at your retail makeup shop make 5% on sales up to $1000, a tiered commission plan would see them make 7% once that $1000 quota has been surpassed. This tiered structure covers the bottom line of the business and adds greater incentive for sales reps to go above and beyond their targets. The idea is to motivate high performers to continue selling, discover new sales avenues and/or upsell product.
Multiplier plans are the most customizable of the options. These plans are ideal for sales reps who have several variables impacting their quotas.
To implement a multiplier, start with basing variable pay as a percentage of a single sale, then multiplying it once a specific quota is achieved.
Harvard Business Review shares an excellent example for businesses where pricing structures vary:
"An office products supplier had a commission plan with a multiplier linked to average selling price performance. Deals booked at more than 3% below list price earned the salesperson a base commission rate. For deals booked within plus or minus 3% of list price, salespeople earned the base commission rate times a 1.1x multiplier. For deals booked at more than 3% above list price, salespeople got the base rate times a 1.25x multiplier. The multipliers discouraged salespeople from conceding price in order to outperform on volume."
Put simply, multipliers are used to help reflect the sales cycle and keep sales reps motivated to make sales where the business needs them most.
Straight Commission or Commission Only
As you can imagine, this commission structure is based on paying sales reps solely on commission without base pay. With such a structure, sales reps are encouraged to maximize the number of deals they close. Keep in mind, reps will be motivated to close every sale, regardless of whether or not they align with company goals.
Do you have sales reps spread across different regions and territories? If you know your target market and where they're located, commission via territory volume might be right for you. Instead of individual sales commission, territory volume commission is paid according to territory-wide sales goals. It incentivizes teamwork and participation if sales goals are to be met. It also may help prevent competitors from poaching customers in areas you already control. However, keep in mind that this commission structure will restrict your sales reps from following people who leave the region or selling to those out-of-territory.
New Business vs. Old Business
This structure is typical of agency type businesses. It rewards sales reps for bringing in new clients or opening up new opportunities. At the other end of the spectrum, sales reps may also be rewarded for renewing or maintaining existing contracts. Reps would receive residual commission according to the lifetime value of the client. Depending on company goals, this may force your sales reps to spend the majority of their time servicing old clients or talking to new ones.
By now you've realized that the right sales commission structure for one business won't be the right one for another. The right choice always depends on the goals of the business. Are you focused on growth? Are you looking to expand to new territories? Or are you trying to reach a new marketing segment? The commission structure you choose will directly influence the behaviour of your sales reps.
If you can, try testing different sales commission structures with your sales reps. This way, you'll receive feedback from both the balance sheet and the people on the sales floor.