A Guide to Sales Commission Structures

Feb 17, 2020
Reading Time: 5 minutes
Written by Daniel Fane
With the right commission structure, you can elevate your businesses sales team’s motivation, productivity and effectiveness. Indeed, incentivising employees correctly will help promote your business entirely. However, as with any business decision, there are many different forms these structures can take. Here we give a brief breakdown on some of the most popular commission structures, and why they may/may not work for your business.

Straight commission structure

Under this, the sales reps don’t receive a base salary and instead make all of their money off sales commission. Normally, without the base salary, this means the rate of commission is significantly higher than in other structures. However, this structure proves particularly valuable for and popular amongst, start-ups.

A straight commission allows unestablished businesses to encourage performance with large incentives without having to guarantee salaries. Indeed, they may also promote a higher rate of productivity as more efficient, longer working hours by employees will likely result in greater pay.

Likewise, a straight commission agreement normally means that these ’employees’ are actually considered contractors. In turn, this retains benefits over tax and other employee expenses within a typical workplace.

However, the caveat to these benefits is the promotion of long-term company stability. As employee success is almost entirely self-dependant, the risk they take on is high. Hence, small talent pools with high turnover rates are often experienced by these businesses. So, while this structure may be valuable to a new business, it may need to eventually be adjusted with time to create employee stability.

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Base salary plus commission structure

Rather striaght-forward in practice, this structure involves the employees retaining a base salary and receiving a commission in addition to it. However, this commission will likely be at a much lower rate than with a straight commission structure.

The main benefit of this structure over the straight commission is that it is likely to invoke higher employee retention. The greater job security, coupled with the incentives of commission, provide a good balance within established businesses.

However, the downside to these is that these base salaries now mean these sales reps are employees rather than contractors; involving greater tax expenses and requiring greater guarantees. Likewise, for younger companies, there is a greater risk taken on in guaranteeing salaries on top of the commission. These all come out of the businesses bottom-line in the end. Though, arguably, the benefits for productivity outweigh these negatives.

Commission calculation structures

An important consideration is how these commission rates are to be calculated. A wide array of options exist, each a little more complex than the other. Below are some of the most popular options.

Revenue commission

This is the simplest of any of these rates. Simply, for any revenue generates by the sales rep they will receive a percentage of it in commission. For example, a $15,000 sale at a 10% rate will result in a $1,500 commission. The benefit here is the simplicity of the calculation. Likewise, the often higher commission for the rep will encourage better performance. The downside is that revenue is a simplified figure and will eat into business profits. Next, we discuss an option that somewhat mitigates this.

Margin commission

Here, the commission is taken from the margin between the expenses incurred and revenue generated by the sale. This helps protect company profits more-so than the revenue commission rate. So, for example, if our previous $15,000 sale incurred $5,000 worth of revenue expenses, our margin commission at 10% will only be $1,000 (($15,000 – $5,000) x 10%).

This method also encourages sales for products/services with the greatest profit margins, resulting in greater profits for the rep and the company. Likewise, it disincentivises reps who rely on discounts to close deals. Though, while this will also increase profit margins, it may also alienate certain customers looking for competitive rates.

Tiered commission

This structure works in tandem to the prior to options. Tiered commission refers to a dynamic rate. For example, 5% for sales up to $10,000, 7% between $10,001 and $15,000, etc. Obviously, incentivising greater sales enables a mutual benefit between the employee and business. However, it does also mean that the bigger the sale, the more the business loses out on.

Though, this may be set off by the increase in effectiveness and overall profit growth experienced by the company.

Commission draw

The most complex of these structures, a commission draw almost acts like a salary loan structure. Under this, employees are provided with a ‘draw’ for each salary cycle. This draw acts as both a minimum sales commission threshold, as well as a base salary for the employee. On each cycle, the employee will receive this draw value minimum. However, depending on their performance that cycle they may receive more than this draw or potentially owe the business money at a later date.

This is a little confusing, but an example should make it clear.

Our employee has a set draw of $7,000 a cycle. During the cycle, they make $8,000 in commission from sales (calculated at whatever predetermined rate). Hence, under the draw, they will simply receive that $8,000.

However, say that employee only generated $6,500 in commissions. They will receive the full minimum draw of $7,000. BUT, they will then owe the company the extra $500. It’s almost like a loan system.

The main benefit to this system is it ties performance to a (kind of) base salary directly. Employees receive some sort of security in receiving consistent income, though with the caveat of performance. Likewise, companies can hedge their employee’s performance. If their sales are struggling, the money their employees owe them can help offset lower revenue.

However, how the business calculates the draw value poses issues. The draw has to be tailored to each employees performance. So, if an employee slumps, their draw may be too high and they end up owing the business a lot of money. Hence, this system requires quite intense performance forecasting and should only be used if such consistent resources for tracking are available.

Likewise, it is a more stick than carrot system. While it provides a commission to employees, performance is driven by a fear of debt rather than a goal of profits.

Final thoughts

Ultimately, commission structures are a great way of incentivising employee performance. However, picking what best suits your business may be tricky. We advise that you seek as much advice as is possible prior to implementing a structure. Likewise, even after doing so, track how it is affecting performance. These options aren’t binary. Make variations to them where necessary to help them suit your business best.

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