Whether you're in the sales industry or are considering a career change to a sales-based position, it's important to understand how commission structures work. Because most salespeople are paid through some type of commission, what and how much they sell impacts their annual household income. In this article, we define commission structure for sales and provide examples of each.
What is a commission structure for sales?
A commission structure in the sales industry details how companies compensate their sales associates. There are several types of sales commission structures that result in different levels of pay. Commissions can be paid on a weekly, biweekly or monthly basis. Most are paid at the end of the period but can be delayed if employers need to receive payments from clients before paying you.
Importance of an effective commission structure
Key considerations for companies to keep in mind when creating an effective commission structure include fairness and accuracy. Sales associates who feel they're being paid fairly are more likely to stay with companies rather than leaving for better opportunities. Effective structures include the right mix of salary and commission as well as reachable quotas. How a company pays its salespeople can affect profitability while helping attract and retain the best sales force.
Nine types of sales commission structures
There are a variety of sales commission structures that businesses use depending on their services or products. The nine most common structures include:
1. Base rate only commission
The base rate only plan pays sales representative an hourly or flat salary. This commission structure benefits businesses where salespeople spend a lot of time educating and supporting customers before and after sales. There’s no incentive to upsell or sell more products or services.
- Example: The company’s four salespeople each earn $1,250 a week no matter how many sales they make.
There is no calculation needed since no commission is paid.
2. Base salary plus commission
The base salary plus plan is one of the most common commission structures. It provides salespeople with an hourly or straight base salary plus a commission rate. Typically, the base salary is often too low to support someone's income entirely but it does provide a guaranteed income when sales are low. The standard salary to commission ratio is 60:40 with 60% being the base rate and 40% being commission-driven. The plan best serves as an incentive or motivation for increased sales performance.
- Example: A salesperson earns $500 a month in salary with 10% commission, or $500, for $5,000 worth in sales. If he sells $20,000 of product in one month, he earns $2,500: $500 in salary and $2,000 in commission.
Calculation for base rate only commission:
Commission Percentage x Amount Sold = Commission Total.
3. Draw against commission
The commission draw plan is based on an advance payment, or draw, that helps new hires acclimate to their sales roles without losing income. It incorporates elements of the commission-only and base pay plus commission structures. The more you sell, the more you make in commissions.
Sales representatives earn a salary, or draw, each month for a specified time regardless of sales. If they earn less in commission than they do in salary, they keep the commission and the difference between it and the draw amount. The funds are considered advanced payments until commissions reach or exceed the salary draw. These advanced payments must be paid back eventually to employers. The salesperson only profits if commission totals are higher than the draw amount.
- Example: A salesperson is expected to earn $4,000 a month in commission and receives $2,000 a month in draw. If they met their $4,000 goal, they earn $2,000 more, the amount over the draw. If they earn only $1,000, they owe the company $1,000, the amount under the draw.
Calculation for draw commission: Commission Total - Draw = Commission Owed.
4. Gross margin commission
The gross margin commission model factors in expenses involved with the products being sold. The salesperson earns a percentage of the profit. Because their commission depends on the final cost of the sale, salespeople are less likely to discount products. The more they can upsell a product or service, the more commission they can earn.
- Example: A salesperson is selling a $100,000 car that costs $60,000 to make. The gross margin is $40,000. The salesperson earns 5% on the margin or $200 in compensation.
Calculation for gross margin commission: Total Sale Price - Cost = Gross Margin. Gross Margin x Commission Percentage = Total Commission.
5. Residual commission
The residual plan benefits salespeople with ongoing accounts or clients. As accounts continue to generate revenue, commission payments continue. The structure encourages salespeople to retain their customers or develop repeat business. This structure is most common in agencies and consulting firms that handle long-term accounts.
- Example: An insurance salesperson lands a large account. As long as that company pays its premiums of $3,000 a month, the salesperson receives 5% commission or $150 each month.
Calculation for residual commission: Payment x Commission Percentage = Total Commission.
6. Revenue commission
Companies more concerned with larger business goals than total profit commonly use the revenue commission model when setting commission rates. Sales representatives who earn a predetermined percentage of the revenue they generate have the opportunity to become top sales performers.
- Example: A car salesperson sells a $25,000 vehicle and earns 3% of the sales. They receive $750 in revenue commission for that sale.
Calculation for revenue commission: Sale Price x Commission Percentage = Total Commission.
7. Straight commission
Salespeople who work on straight commission only earn money when they complete a sale. No sale equals no income. Since the company doesn’t provide a base salary, it can offer higher commission rates which often attracts the best salespeople. The straight commission structure allows salespeople to function like independent contractors who set their own hours, which saves companies money in taxes, benefits and other expenses. The company is out money only when the salesperson brings in revenue.
- Example: A telemarket that sells vacation condo rentals earns $150 for every booking. The more time put in on the phone, the greater the chance of making a sale.
Calculation for a straight commission: Sales x Commission Rate = Income.
8. Tiered commission
In the tiered commission model, salespeople earn a certain percentage of commission on all sales up to a designated amount. Once they achieve their revenue goal, their commission increases. This encourages them to exceed sales goals and close more deals.
- Example: A salesperson's base commission is 5% up to a total of $100,000 in sales. That commission increases to 7% for total sales between $100,001 and $200,000. Any sales over $200,001 earn them 10% in commission.
9. Territory volume commission
In this model, salespeople earn their income based on the set rate for their defined region. The amount of compensation typically depends on territory volume, where sales numbers are totaled and commissions split equally among salespeople within the region. This compensation plan will only work for sales representatives who work in a team-oriented environment.
- Example: Two salespeople are expected to sell $50,000 in product each month in a 100-mile region. One sells $30,000 while the co-worker sells $20,000. Since the total goal has been met, they split the 10% commission, earning $2,500 each.
The calculation for territory volume commission has many factors depending on the company’s sales formulas. A simplistic calculation would be:
Sales Totals x Commission Percentage divided by Number of Salespeople = Commission Total Per Person.
Related: How To Calculate Commission
How to choose the right rate
Outlining your commission structure is one of the most important things a company can do for its sales operation. What works best for one business may not be the answer for another. Here are some tips for finding the right commission structure for your company:
- Determine what results you hope to achieve. This might be customer acquisition for one department but customer loyalty for another.
- Focus on an effective sales process. Determine what sales methods work best for your company to reach its sales goals. Document the results over a specific time to measure their success.
- Turnover typically is high in sales, so don’t be afraid to try new commission structures. What worked as a motivator five years ago may not be an incentive for today’s sales teams.
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