Back To Basics – What is a Sales Commission?
For a long time, businesses have used sales commission-based compensation structures to motivate their teams to work towards the company’s set objectives. This method of compensation makes it possible to recognize and reward hard workers for their exceptional performance in the organization. Besides, paying commissions provides a company with flexible payment terms that don’t rely on a set monthly salary but the generated revenue.
Now, lately we’ve been talking about commissions a lot and it’s possible that you are wondering. What is a sales commission? Here we will provide you with a definition and the most common sales commission structures that you can use for your business.
A sales commission is the amount of payment offered to a salesperson based on the value of a firm’s products they have sold or sales deals they have closed.
Each company has a set formula for calculating the commission which is always communicated to the sales rep or highlighted clearly in the sales contract. The commission can be calculated as a percentage of the product’s price or it could be a set amount for each sale. It’s common for such percentages to change as business goals or trading environment change.
Some businesses will also come up with tiered commission plans. This is where the percentage or value of commission for each sale increases with sales volumes. For instance, the company might decide to pay a commission of 3% for sales worth between $10, 000 and $40,000, 3.5% for sales of value between $40,001 and $70,000 and 4% for sales worth $70,001 and above. This kind of plan encourages sales reps to keep pushing for better results.
Common Sales Commission Structures
There are four different ways of calculating the sales commission, namely:
1. Straight Commission
Using this structure, companies compensate their sales reps only for the items they sell. There are various industries that use straight commission structure including real estate, cosmetics, and most retail sectors. This commission payment structure is suitable for businesses that have short sales cycles (one-call closes) and high-end products that generate large commissions. Additionally, a salesperson who has experience and is confident in their selling skills can also take up this payment structure.
2. Base Salary and Commission
This model of compensation involves a minimum salary and additional commission based on the employee’s sales outcome for the predetermined period. It is a good compensation method for companies hiring new sales reps since the base salary gets them going as they hone their selling skills or build their client base. Having a base salary plus commission arrangement is also suitable for businesses whose products have long sales cycles or involve a learning curve before the salesperson can master the product. A good example of such products is software applications.
But, there are also other reasons many companies consider having a base salary for their sales workers. A common argument is that salespeople don’t spend all their time in a firm selling only but may engage in other administrative and customer support tasks as well. Such tasks performed by salespeople outside selling may include posting customer information in a company database, keying in sales details in a tracking system, attending trade shows to hunt for potential customers and supporting/teaching the customer how to use a product. For this reason, a base salary is one way of compensating for the sales rep’s time spent on these activities.
3. Draw Against Commission
A draw against commission payment model enables workers to receive an advance payment for commissions they might earn in future. Some companies with straight commission structures and products with longer sales cycles offer this payment to their workers to cover for months with low cash flow. Draw against commission is like a loan to the salesperson which the company will deduct from future earnings.
4. Guarantee Against Commission
This commission structure is similar to draw against commission except that the company doesn’t recover the advance payment from the sales rep’s future earnings. How does it work? For companies that pay straight commissions, they can offer sales employees a base salary during months when they are launching a new product which they are not certain about the market response. In this case, salespeople are paid an advance salary irrespective of the sales outcomes for the month. This arrangement can also work for companies dealing with products that have long sales cycles.
Sales and marketing are the oil that fuels the engine of growth in a firm and steers the business right through its success path. But, salespeople need constant motivation to maintain a high performance. Here is where a good commission plan comes into play.