Even if you haven not spent the past few months guilt-binging on “Selling Sunset”, you have probably heard about the concept of sales commissions and just how highly sales reps value them. In fact, the top real estate agent on the aforementioned docu-reality series is rumoured to have raked in an eye-watering $1.2 million commission on a house valued at $40 million, showing that in the high-stakes world of sales, reward can often more than compensate for risk.
While not everyone is engaged in the business of selling multi-million-dollar properties, sales commissions are still a highly effective tool for motivating sales teams. With a strong sales commission structure, you can not only drive your team to perform better, but can also get a better return on investment, thereby achieving two very important organisational objectives in one go.
This article will touch upon what a sales commission is, the pros and cons of having various compensation structures, and how they can be implemented effectively in an organization.
What is a sales commission?
A sales commission is a key element of any sales compensation scheme. It is a monetary reward granted to a salesperson (or a team of salespeople) upon meeting a certain predefined sales objective – for example, upon completing a certain number of sales, or making a sale of a certain value.
Commissions have long been considered one of the most effective ways of motivating salespeople, since they link monetary rewards directly to employee performance. For this reason, several salespeople find commissions both, personally and professionally rewarding.
Although a useful tool, the chosen structure of your sales commission has to be carefully planned in order to incentivize employees without creating a culture of competitiveness or demotivating lower-rung performers. Some popular sales commission models are discussed below, along with the pros and cons of each.
How do sales commissions work?
Different companies adopt different sales commission models, depending on their organisational culture, company goals and objectives, and employee demographics. There is no one-size-fits-all solution, and companies often use a combination of different models or a completely unique commission structure that aligns with their sales objectives.
Some of the most widely known sales commission models are:
1. Base salary plus commission
In what is probably the most commonly known sales commission model, employees are given a base salary plus a commission on every sale. A larger proportion of the employee’s salary is commission-based, but some responsibility falls upon the employer to provide a minimum guaranteed salary regardless of performance.
Example : Francisco works for XYZ Ltd. His base salary is $5,000 per month, plus a commission of 5% on each sale he makes. He makes $50,000 worth of sales in October. His salary will be = $5,000 + (5% x $50,000) = $7,500.
Pros and cons:
- Employees are incentivized to work harder to earn their commission but have some leeway in case of poor performance or external circumstances.
- Your customer quality tends to be higher, since your sales reps are not stressed about closing deals to meet their targets.
- This structure shows that your company is investing in the success of its sales team, thereby reducing employee turnover.
- Employees may not work their hardest, since they have a minimum guaranteed salary irrespective of performance.
- This model is unsustainable for smaller companies with limited budgets.
2. Straight commission
Extremely popular with start-ups on lean budgets, this structure means that 100% of the sales rep’s salary comes from commissions, with no minimum guaranteed salary. In most cases, companies tend to have no upper limit on how much a sales rep can earn in commissions.
Example : Francisco works for XYZ Ltd. He earns a commission of 5% on each sale he makes. He makes $50,000 worth of sales in October. His salary will be = (5% x $50,000) = $2,500.
Pros and cons:
- It provides the highest earning potential for sales reps as there is no maximum cap on commissions.
- It gives sales reps greater income flexibility by letting them determine the number of hours they work.
- This system is ideal for lean start-ups with limited resources and financing.
- Companies have less liability with respect to employee management, since commission-only employees are considered independent contractors, rather than full-time employees.
- Entirely performance-based rewards can cause a competitive and demotivating environment to work in, especially for mid-rung performers.
- This model encourages a high level of employee turnover, since it offers low income stability.
- Customer quality may get affected, since sales reps are eager to make a sale irrespective of long-term customer prospects.
3. Relative commission
A balance of guaranteed and performance-based pay, this model offers salespeople a guaranteed base salary, plus a fixed rate commission paid proportionally on a predetermined sales target.
Example : Francisco works for XYZ Ltd. His base salary is $5,000 per month, his monthly sales quota is $20,000, and his commission rate is 5% (or a total of $1,000, when applied to his monthly quota).
- If he meets only 70% of his monthly quota, his salary will be = $5,000 + (70% x $1,000) = $5,700.
- If he exceeds his monthly quota by 20%, his salary will be = $5,000 + (120% x $1,000) = $7,200.
Pros and cons:
- Employees will be motivated to close more sales, since their performance determines their commission.
- This system results in less competition since commissions are based on individual, rather than relative performance.
- There will be less employee turnover, since it offers greater income stability.
- It can be more complex to implement this in practice, especially with different sales targets and commissions for different employees.
- It can be expensive for employers if there is no cap on earnings from commissions.
4. Tiered commission
Though similar to the relative commission model, a tiered commission structure offers salespeople the added incentive of a higher commission rate for exceeding sales targets. Therefore, a sales rep’s commission rate increases upon meeting certain targets and decreases in case they miss the target.
Example : Francisco works for XYZ Ltd. He has a base salary of $5,000 per month. Additionally, he can earn a commission of 5% for up to $20,000 worth of sales, and 10% for any sales that exceed this amount.
- If he only makes sales worth $15,000, then his salary will be = $5,000 + (5% x $15,000) = $5,750
- If he makes sales worth $30,000, then his salary will be = $5,000 + (5% x $20,000) + (10% x $10,000) = $7,000
Pros and cons:
- Employees will be motivated to surpass their sales even upon meeting their quota.
- Rewards are commensurate with performance, but also offer a minimum base salary to cushion employees.
- Sales reps are motivated to increase the value of their sales revenue via creative techniques such as upselling, since exceeding the quota allows them to earn a higher commission.
- It can be more complex to implement this in practice.
How to implement a sales commission in your organization
Choosing the right commission model is half the battle won. The final task is to educate your sales team about the new system, implement the commission structure, align it with your existing sales pipeline, and continuously monitor its effectiveness to ensure that it is meeting its objectives. Some key tips on managing this effectively are:
- Align your compensation scheme with employee need: One of the most variable dynamics in any sales-related process is the sales team itself! Remember that you are dealing with human beings, not machines, so whatever commission structure you choose should account not just for your sales objectives, but for your employees’ needs as well. Give them a chance to negotiate on their commission rates, if it will help them perform better.
- If possible, do not limit earning potential: Though some of the models described above mention placing a limit on the maximum a sales rep can earn, studies have shown that this can be counterproductive, since it does not encourage employees to push themselves beyond their quotas. So unless prohibitively expensive, aim for a model that, within reason, allows your employees to maximize their earning potential.
- Stick to one plan: Though it may be tempting, you should avoid changing compensation plans too often, since it can not only confuse, but also demotivate sales teams. For this reason, it is important to carry out in-depth research before committing to your chosen sales commission structure.
- Keep it simple and transparent: To keep morale high, it is vital to be communicative and transparent with your sales team, ensuring that they are aware of the various clauses in their sales compensation agreements. Be sure to include any information regarding the compensation scheme, commission rates, and any other relevant clauses. Being as honest and open with them as possible will show that you have their best interests at heart, and motivate them to work harder.
Drafting a sales commission agreement could not be easier, thanks to the smart features that Contractbook offers. Negotiate with your employees through collaborative document creation, automate sales commission agreements with members of your sales team, collect digital signatures, and much more – all in an easy-to-use, clean interface.