I am going to let you in on a secret. Companies aren’t worried about meeting their revenue goals as much as they worry about losing amazing sales folks. If you think about it, it pans out right? High-performance sales teams = revenue goals met. And, to make sure sales people stay, what do you do? You reward them fairly. And, how do you do that? Incentives!
In this blog post, we’ll talk about one of the main things that keep the Ops teams up at night: sales commission structure. If you’re new to incentive compensation, then this is the right place. We’ve written this piece so that you can get a good night’s sleep. Read on.
First up, the basics.
What is a Sales Commission Structure?
Unlike engineering roles, salespeople don’t have a 100% fixed salary paid out to them every month. They have something called OTE (On-target-earnings). On-target earnings are a mix of fixed salary and a variable incentive pay with 50 to 75% being the fixed part.
Sales commissions structure defines how sales reps get paid for their variable incentive pay. You have a target and the % of commissions paid out is proportional to the target achieved.
Why are Sales Commission Structures Important?
Sales commissions are one of the best ways to ensure skin in the game for sales people. Sales is not a qualitative job. Their impact on the company can be reasonably quantified and measured.
Commissions structure helps you establish just that and reward reps based on their impact. In this case, it is the business they close for the company.
Now that we know what the sales commission structure is and why it is important, onto its types.
Types of Sales Commission Plan/Structures:
For the sake of this exercise, let us assume that the OTE of a sales rep is $200K and structure all our examples around that.
Base Salary Plus Commission Plan
Base Salary Plus Commission Plan is one of the most common ways of configuring sales commissions structures. It includes a base component that is fixed and paid out every month. There is also a commission component paid out quarterly or monthly. This depends on how the targets are set for the sales role. For example, 60% is fixed pay and 40% is the commissions component.
$200K OTE = $120K Fixed + $80K Commissions
How we calculate the $80K commissions is a different endeavour altogether. Head to our compensation guide to know how. In most scenarios, it is a percentage of the product value sold.
If a rep has a 8% flat commissions rate for every sale, then to attain $80k in commissions, a rep has to make $1M worth of sales.
When to use?
Since it is the most common way of compensation, it should be your go-to plan for sales compensation unless you have some unique insight that might suggest otherwise.
Pros: Sure shot and battle tested standard plan that ensures reps get a fixed salary every month.
Cons: There are some specific scenarios where this may not work out which we will address below.
Straight Commission or Commission Only Plan
Straight Commission or Commission Only Plan is quite an aggressive commission plan. The commissions are the only form of payout for sales reps. It is a very high risk plan to undertake and hence, rarely used in big companies.
When to use?
It is reserved for companies whose sales are purely transactional. A very commercialized product that is well-known or something like an insurance product might have sales teams that fall into this kind of model.
Pros: It reduces upfront costs for the company. The risk taken by the company is close to nil as they only pay the reps if they bring in revenue.
Cons: Sales will be mercenaries and might leave anytime without any commitment to your firm as they don’t get a fixed salary.
Gross Margin Commission Plan
A slight variation on the revenue commission model is the gross margin commission, which takes into account the expenses associated with the products you sell.
Rather than earning a percentage on the revenue, sales reps earn a percentage of the profit.
Total Sale Price - Cost = Gross Margin.
Gross Margin x Commission Percentage = Total Commission.
Pros: This kind of sales commission structure is reserved for very old-school well established traditional businesses or service businesses. There might be variable costs involved and hence difficult to pay reps purely based on sales.
Cons: This model doesn’t incentivize growth. Reps have a hard time selling a product. It gets more difficult with a gross margin to keep in check.
Tiered Commission Plans
In a tiered commission structure plan, you are rewarded for how good your target attainment is instead of the revenue impacted.
So, if you attain less than 100%, you get paid your incentive pay at 1x and above 100%, the additional attainment is paid out at 2x and so on.
When to use?
This is reserved for companies that want to retain parity among reps regardless of their revenue impact. This is also used when reps sell a product in one currency but get paid out in another currency
Pros: Tiers create a sense of fairness among reps ensuring they get paid on their target rather than revenue. Reps can have different quotas and the ones with lesser quota will be benefited by such a model.
Cons: It somewhat restricts your earning potential to an extent. A commission rate model incentivizes you for every $ regardless of the target attainment and gives much more lucrative rewards once you are able to hit the home runs.
Draw against Commission
In sales, draws can mean one of two things: an advance against commissions or a guarantee paid out during times of sales uncertainty.
Draws dictate a reps’ personal cash flow. There are 2 types of draws,
- Recoverable draws
- Non-Recoverable draws
When to use?
Recoverable draws are paid out as an advance against commissions and are used in the following ways:
- Seasonal business where reps may run dry of deals in a quarter
- Incentive heavy compensation plans where reps are heavily dependent on closures
- Longer sales cycles where deals that take a year and above to close
Non-recoverable draw payments made to the sales rep, as the name suggests, can’t be completely recovered.
They are used in cases given below:
- New hires get a guaranteed draw during their initial days to ease them in
- Guaranteed payouts during unforeseen circumstances like storms or COVID
Pros: They are paid as a goodwill gesture by the company during certain periods of uncertainty and to ensure that reps are motivated.
Cons: When it comes to recoverable draws, if not enforced properly, reps might get paid unfairly and might leave the firm mid-way, if they know a clawback is coming their way.
Base Rate Only
This is a model where sales people don’t have commission plans. It is a modern way that has been adopted by very specific firms to show that commissions cause unnecessary pressure and sales reps can be trusted to bring in business even without them.
Atlassian is one of the few widely known firms with this model. There isn’t enough data to deep-dive into this structure.
Territory Volume Commission Plan
This is a model where reps are compensated based on the collective team performance rather than their individual performance. It is widely used by companies with a retail sales model where multiple reps end up assisting a sale.
Sales Commissions = (Store/Territory Total Sales * Commissions %)/ # of Reps
When to use?
Whenever you can’t directly attribute new business closed to a single rep, this model is preferred to ensure collaboration and teamwork.
Pros: It helps keep all sales reps aligned towards a common goal and common reward.
Cons: If a sales rep is doing a very good job, this model might not give them a lot of room to make additional incentives. It caps them to the average of the group.
Now, you’ve picked out the type of commission structure suitable for your business. What then? You need to structure it for your sales teams.
How to Structure the Sales Commission?
Step 1: Determine the Best Sales Commission Structures for Your Team
All of the above models suggest that there is no right model that works for every business. You need to adopt what works best for you based on your business.
One of the best ways to go about sales commissions is to keep it standard and simple and then expand and experiment with different models only when it is not working for you. There are few important factors that you can use to experiment.
Step 2: Evaluate the Stage Your Company Is In
If you are a growth stage company, you might want to go aggressive on the sales commissions structure to close as many businesses as possible. In case of a cash-strapped company, you might look into a conservative approach with a lot of incentive pay compared to fixed pay.
Step 3: Evaluate the Industry of Your Company
If you are in a traditional industry where there is already a common way of sales commission structure that your reps are going to be well-versed with, complicating those with new models is not going to help you with hiring new hires.
In a saturated market, you can use aggressive commission structures as a way to attract new reps.
Step 4: Study Past Performance of Your Sales Team
Any new commission plan will take 1 year to fully show results. So, if you want to evaluate comp plans, you should always look at 2 to 3 quarters for specific hypotheses to validate. Changing and adding new variables every year is a must if you want to remain competitive with the market.
Step 5: Check Alignment of Company’s Budget and Sales Goal?
Sometimes, your finance team may not be able to afford the commission plan that you might have envisioned. Always keep your leadership and finance team aligned with regards to what the company can afford to spend for a particular sales goal. Promising something in advance without ensuring alignment is a sure shot recipe for disaster.
Step 6: Check if Your Plan Accounts for High and Low Performers
Certain companies go really hard on commissions for the top performers while they penalize the low performers a lot. Sure, this sounds sensible but if every team decides to not pay the low performers, then you are going to have serious employee trust issues.
Some reps might take a few quarters before they are fully ready. Always be considerate on low performers and ensure there is a fair plan available for them if they want to improve.
Sure, sales commissions structure is in no way one-size-fits-all but you can always look for general thumb rules for guidance and understanding of your case.
What Is The Typical Sales Commission Percentage?
The typical sales commission % is between 8 to 12% of business closed by a rep for high growth industries. It doesn’t exceed 18 to 20%. On the lower end, it starts as low as 2% commissions for traditional industries.
Sales commission structures are one of the best levers available to you to boost your revenue. Please use it wisely with deliberate choices and clear goals. If you go careless on it, you will surely have a hard time scaling your revenue and maintaining your sales team morale.