Balancing Motivation and Profitability

Sales commissions are a fundamental component of compensation plans, designed to incentivize performance and drive business growth. However, designing an effective commission structure requires a balance between motivating sales teams and ensuring company profitability.

In this article we explore the different types of commission structures, their benefits and drawbacks, and key considerations for choosing the right model.

A well-structured commission plan can lead to increased productivity and job satisfaction, while a poorly designed one can result in confusion, frustration, and even high turnover rates.

Types of Commission Structures

1. Straight Commission

   • Salespeople earn a percentage of each sale with no base salary.

   • Pros: High motivation, cost-effective for employers.

   • Cons: Income instability for employees, potential for high turnover.

   • Formula: Total Pay = Sales x Commission rate

   • Example: A real estate agents earnings 3% of the sales price of a house. A sold house at $500,000 would then earn the agent a 3% commission worth $15,000.

   
   

2. Salary Plus Commission

   • Combines a fixed salary with commission-based earnings.

   • Pros: Provides income stability while still incentivizing performance.

   • Cons: Higher fixed costs for employers, potential for lower motivation compared to pure commission models.

   • Formula: Total Pay = Fixed income + (Sales x Commission rate)

   • Example: A car salesperson earns a monthly fixed income of $3,000 plus 3% commission on sales. The salesperson sold cars worth $180,000 last month thus the Total Pay is $3,000 + $5,400 = $8,400.

     
     

3. Tiered Commission

   • Increasing commission rates as salespeople hit certain targets.

   • Pros: Encourages overperformance, rewards top performers.

   • Cons: Can create pressure and unrealistic expectations.

   • Formula: Total Pay = (Sales below tier threshold x lower rate) + (Sales above tier threshold x higher rate).

   • Example: A Software Account Manager earns 10% on sales up to $30,000 and then 15% above $30,000. The Account Manager sold software worth $55,000 thus earning 10% of $30,000 and 15% of the remaining $25,000 for a total pay at $6,750.

     
     

4. Profit-Based Commission

   • Commission is tied to profit margins rather than revenue.

   • Pros: Encourages selling high-margin products and services.

   • Cons: Can be harder to calculate and track.

   • Formula: Total Pay = Net profit x Commission rate,

   • Example: A Salesperson from an heavy machinery company earns 8% of the net profit from each deal. A recent deal earned the company a $55,000 net profit hence the salesperson earns a commission at $4,400.

     
     

5. Team-Based Commission

   • Commissions are shared among a group rather than individual contributors.

   • Pros: Encourages collaboration, reduces internal competition.

   • Cons: Can lead to free-riding and reduced individual accountability.

   • Formula: Total Pay per person = (Total sales x Commission rate) / # team members

   • Example: A project team at an architect firm won and sold their project worth $700,000. The 5 person large team’s commission rate is 6% hence each team member earns a commission at $8,400.

     
     

6. Residual Commission

   • Benefits salespeople with ongoing accounts or clients. As accounts continue to generate revenue, commission payments continue.

   • Pros: Encourages long-term customer retention and repeat business.

   • Cons: Can create long-term payment obligations for the company.

   • Formula: Total Pay = Recurrent payment from customer x Commission rate

   • Example: An insurance sales rep has 80 clients with a total of $560,000 in annual premium payment earning 15% in commission. The sales rep will earn $84,000/year or $7,000 per month.

     
     

7. Combination

   • It is common to see a combination of the structures above. Either combining a fixed salary with commission mechanism for all or deploying different structures based on seniority, position, product categories and more.

Key Considerations When Designing a Commission Plan

1. Industry and Sales Cycle

   • Longer sales cycles may require higher base salaries with milestone-based commissions. With no base salary, your sales reps risk earning little no income whilst working on a large project that can take months to close

   • For a more transactional sales cycle, you may benefit from a straight commission models.

     
     

2. Consider company goals

   • Rapid growth? Aggressive commission structures can be effective might be more effective paying the highest earners a relatively large commission. Consider how discounts and your COGS impacts this method as high revenue doesn’t necessarily yield a large profit.

   • Profitability first? Consider the profit-based commissions if your business have a more variable direct cost and you have a wide product portfolio. This can help push products or services where you have the highest margins and but will also force your sales reps to consider discounts as heavily discounted sales might not earn much commission or perhaps no commission at all.

     
     

3. Clarity and Transparency

   • Overcomplicating your commission structure, might impede the motivation and incentive by sales reps if they don’t fully understand how their commissions are calculated.

   • Complicated structures can lead to disputes and disengagement. The last thing you want to end up with, is a dispute with your best performing sales rep about how her/his commission is calculated and whether it’s correct or not.

     
     

4. Flexibility and Adjustments

   • Market conditions change, and so should commission plans.

   • Regular reviews ensure alignment with business objectives.

   • Gain market insight from competitors and how they structure their plans. Your top performers might be getting an offer from your biggest competitor who has a much better incentive that you do.

   • You can also combine multiple structure thus giving Salary Plus Commission for 6-12 months to then transition into Straight or Tiered commission after the initial phase.

     
     

5. Simulating structure

   • When implementing or changing a commission structure, we highly recommend that you simulate the structure you have in mind using historical data.

   • Take sales performance from previous years and run it through your structure to simulate the compensation your staff would be receiving and benchmark it against current compensation or competitors.

     
     

Conclusion

Choosing the right commission structure is a strategic decision that impacts both sales performance and company profitability. The best approach depends on the nature of the business, the complexity of the sales process, and the motivation of the sales team. By carefully considering different models and aligning incentives with company goals, organizations can create a commission structure that drives sustainable growth and keeps sales teams engaged.