A sales commission is paid when any sale is generated or when cash is procured from customers. It is the compensation paid to a person based on the number of sales they have generated. Generally, this commission amount is a percentage of the total sales generated and is paid on top of the base salary of the individual.
Calculating the Sales Commission
The calculation of a sales commission is based on a variety of incentives. Commissions may also have to be split in case more than one person facilitated the sale transaction. Calculating a sales commission will depend on the structure of the commission agreement. The factors which will apply to the calculation are as follows:
- Commission Rate – It is a percentage of the total sales or a fixed pay that is associated with a certain amount of sales.
- Commission Basis – The sales commission is dependent on the total amount of a sale and various other factors. A profit-based commission can be used by the management when there are differences in the profitability of products, and they want to give incentives to the sales staff selling the more profitable items.
- Commission Overrides – A different commission rate can be applied if a certain sales target is reached by an individual or team.
- Commission Splits – In case more than one salesperson is involved in the sale, the commission is split between them.
- Payment Delays – Usually, the sales commissions are paid based on sales made in the previous month. However, it can be difficult to collect accurate information for past sales and hence, calculating the commission amounts. This can often result in a delay in making payments to the sales personnel.
Advantages of structuring sales commissions
- Effective retention of salespeople – There are a lot of turnovers in sales departments. However, losing an experienced and skilled sales talent will affect the sales targets for a company. Moreover, owing to the high competition across sales roles, hiring new talent is extremely tough. The best possible way to reduce the turnover rate is to provide high commissions to the salespeople according to industry standards.
- Greater productivity – With commissions, salespeople are encouraged to sell more. Every closed deal will add to their pay check and help them align their personal goals with the targets of their company. Sales Commission structures can help develop healthy competition within the team, which will increase the salespeople’s productivity and motivation.
- Improved payroll management – A sales commission structure will make sure that salespeople are paid as per the results they bring. This will help the salespeople increase the variable component of their salary. The variable pay may be in the form of incentives or commissions according to the nature of the business.
Types of sales commission structures
Sales Commission structures differ across teams. However, it is important that the chosen structure is profitable in the long run. Let us look at some of the commonly used sales commission structures:
- Commission-only jobs – In this case, the entire pay check of the salesperson is made of their commission earnings. Their income will be dependent on the number of deals they can close. This results in better motivation for salespeople who close as many deals as possible. However, it is also highly stressful as there is no fixed pay for the work and the risk is high. This can lead to high attrition among the sales staff.
- Base plus commission pay – Here, the commissions can be capped as well as uncapped. The commission percentage may differ across various industries and roles. At the same time, salespeople have a fixed pay to safeguard them if they make fewer sales in a period. The sales commission will be an added incentive for them to give their best at increasing the sales.
- Tiered Commission – The commission percentage can change according to each tier, which is defined by outcomes. The salesperson will move up the sales tiers according to their performance. With each tier, the commission percentage they earn will increase. The tiered Sales Commission structure is beneficial to all types of salespeople. Good performers will quickly move up the tiers and will plan their sales strategies accordingly. However, this structure requires proper tools to track the progress of the salespeople and calculate their pay.
- Gross Margin Commission – The commission percentage is applied only to the profit amount in this sales structure. This results in an improvement in the overall profitability of the business. However, it may also reduce the number of deals closed and prolong the sales cycles.
- Residual Commission – In this sales commission structure, a commission is sanctioned for every renewal that a salesperson makes. This results in high customer retention as salespeople will focus on spending a significant amount of time in building client relationships. The sales staff can also earn a large and steady commission. But to earn good pay, every salesperson will need to renew many accounts.
- Territory Volume Commission – Here, the commission generated in total from one geographical location is divided between all the salespeople. The territory volume commission enables effective team building. It also helps businesses expand and scale up much faster. With every new region, the commission rates need to be reviewed, which can have a negative impact on the sales performance and lead to rivalry within the team.
- Draw Commission – A part of the commission is given to a salesperson as a lump sum in the draw commission structure. The lump sum is an excellent motivating factor to deliver better results. However, the draw commission model may result in a complex payroll calculation system.
- Agent commission – This defines a form of payment made to a sales agent where the agent will receive a percentage value for every transaction that a client completes.
There are many effective sales commission structures for sales representatives. The type of product being sold, customer profile, and the sales cycle’s length determine the commission type that is offered. A sales commission plan will define how a sales rep will get his compensation. This is dependent on the sales, volumes, task completion, etc. For most of the sales commission structures, a fixed amount will be combined with a variable amount. Here, one part of the salary is fixed and the other is dependent on the performance of the salesperson. Such structures motivate the top performers and encourage accountability as well as profitability for the business.