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All About Sales Commissions

The What, the Why & the How

What is Sales Commission?

Sales commissions are one of the major driving forces for salespeople. I bet you already know that. While deal closures play a fantastic role in keeping up the spirit of sales reps, there's nothing quite like being lucratively rewarded for your hard work.

Sales commission is the monetary compensation that salespeople earn on top of their base salary for the deals they close. It is calculated based on the sales quota they’ve attained over a specific period of time, which can be monthly or quarterly.

Commissions are variable in nature. To define them properly, you’ve to consider a number of components like your revenue goals, the role of your salesperson, time period, etc. Commissions should make your salespeople motivated and keep them on track to hit their quotas. They have to be set in a fair manner, and can be a misfire if not thoughtfully done.

So, how do you ensure that you are paying your reps fairly and making the most out of your incentives program? Go on and build a killer sales commission structure.

What is a Sales Commission Structure?

Sales reps aren’t paid a fixed salary every month. They have OTE (On-target Earnings) which defines the base pay and variable pay.
Sales commission structure, a.k.a sales commission plan, details out the components that define how reps will be paid based on their performance. The components can vary depending on the role of the rep. While AEs are compensated for deal closures, SDRs will be compensated for their activities like number of calls made, meetings taken, SQLs generated, etc.

Why Do You Need an Effective Commission Structure?

Commission plans are an important cog in the sales wheel. But, bear in mind that these plans work only when they are fair and effective. Here’s why:

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How to Create a Sales Commission Structure

Assess the Stage of Your Company

When you are in the hyper-growth stage,  you set your targets to rapidly expand your customer base. In this case, you might need an aggressive sales commission structure. On the other hand, a traditional approach of having a higher ratio of incentives to base pay can work if you’re a cash-strapped company.

Analyze Your Industry

Before you set off to make a comp plan from scratch, take a look at how companies in your market are already handling commissions. Here’s why: you can take what has already worked before instead of trying out new tactics that might or might not take off. In a saturated market, you can choose more attractive components to hire new talent.

Evaluate the Past Performance of Your Sales Teams

When you’ve created a new sales commission plan, it will take at least a year to measure its impact. To truly validate a particular component in the plan, consider its impact over at least 2-3 quarters. And, if you want to lead the race in your market, don’t hesitate to tweak your plans and add new components if necessary.

Align Your Sales Goal with the  Company’s Budget

As a business, you’d want to compensate your reps well, help them reach their goals, while also achieving your revenue target. But it’s important to be practical and realistic when creating a commission plan. This is where alignment comes in, where you communicate your plans with the leadership & the finance team to understand the budgets. Sometimes, a plan may not be feasible budget-wise, and without proper alignment with your management and finance, you could be in trouble.

Ensure Your Plan Accounts for High and Low Performers

In some cases, the top performers are generously rewarded, and the low performers are penalized. This can create distrust and demotivation among your reps. Every rep has a different pace and you cannot expect all reps to perform at the same level. Therefore, take some time to evaluate where your reps stand and whether your plans work in motivating every single one of them. You wouldn’t want a low-performing rep to think your goals are unattainable for them.  They may take a little more time to perform consistently. Take them into consideration and design a plan suitable for them.

Choose the Best Sales Commission Structure for Your Team

Here’s a fact: there is no right or wrong commission structure for your business. You need to adopt what works best for you and your reps. Closing a deal is hard as it is, and your reps do it day in and day out. So, it’s only fair that you pay them generously. To attract and retain your top performers, a lucrative commission plan is a must-have.

You can keep the plans standard and simple at the beginning. Experiment with different models in case your plan isn’t working for your business.

Learn more

Types of Sales Commission Structures

1. Base Salary Plus Commission Plan

This plan includes a fixed salary and a variable amount. The fixed salary is the guaranteed pay that a rep gets every month and the commission is paid either monthly or quarterly based on the quota percentage they have attained. In general, the  fixed to variable pay ratio is 60:40. Having a base salary can give your reps a much-needed sense of security when sales slow down, while the commission amount would keep them motivated to reach their sales target.

When to Use It

This is the most commonly-used sales commission plan and can be your first choice when you want to design a plan. Also, select this plan if retaining your reps is crucial for the success of your business. This may not be your go-to plan in certain cases. For instance, if you want your reps to overperform and exceed their quotas, a Tiered Commission Plan would be a better fit.

2. Straight Commission

A commission-based sales rep doesn’t have a base salary, and reps are paid only depending on the sales they make. The commission rates are higher than in other plans, and you save money on taxes, benefits, hiring, etc.

When to Use It

If your deals are purely transactional, this plan works well. Also, if your sales cycle is shorter, or you’re a start-up with little capital, go ahead and choose the straight commission plan.

3. Gross Margin Commission Plan

Here, sales reps earn a percent of the profit generated rather than the total deal amount. Since their commission is based on the final sale amount, reps are unlikely to provide discounts. They can earn more as they do more upsells.

When to Use It

If you’re looking to grow your sales team, and scale your business, then it’s best to choose this commission plan. It keeps the reps motivated, and also maintains your bottom line.

4. Tiered Commission Plans

Once your reps hit their quota, they wouldn’t be motivated to close further deals since they won’t be incentivized for doing so. Further, they’d push the deals to next quarter, where they’ll be incentivized. The tiered commission plan solves this problem, as reps are paid directly depending on how well they perform. The more deals they close, the higher their commission will be.

Here’s how it works: 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. This keeps on increasing as you reach new targets.

When to Use It

When you want to motivate your reps to exceed their quotas, you can bank on this sales commission plan. You can also use this plan when reps sell a product in one currency but get paid out in another currency.

5. Draw Against Commission

Draws mean one of the following two things: an advance against commissions or a guarantee paid out during times of sales uncertainty. Reps may or may not return the amount depending on the type of draw you choose. There are two types of draws:

Recoverable Draws

Recoverable draws are the amount paid in advance to sales reps at the start of a pay cycle. By the end of the sales period, the actual payout of reps is calculated, and they’re paid the difference between the advance given and the final commission number. In general, the advance is between 30-60%, and it’s based on the size of the incentive percentage and how likely reps would achieve their numbers.

When to Use It

  • You’re a seasonal business where reps may run dry of deals in a quarter
  • You have an incentive-heavy compensation plan where reps are left with no choice but to close more & more deals.
  • You’ve longer sales cycles where deals that take a year and above to close

Non-Recoverable Draws

It’s the draw amount paid to reps which cannot be completely recovered back. Non-recoverable draws can be combined with advance commission plans if required. But it’s advisable not to do so because if the final payout is less than the commissions of reps, you’ll just have to forfeit the difference.

When to Use It

  • New hires get a guaranteed draw during their initial days to ease them in
  • Guaranteed payouts during unforeseen circumstances like storms or COVID

6. Base Rate Only

The base rate only commission plan doesn’t have a variable pay. Rather, reps are paid on an hourly basis or have a fixed monthly salary.

When to Use It

This plan is used in firms where reps are focused on generating inbound leads, where they get to spend a lot of time doing the supporting role rather than hardcore selling.

7. Territory Volume Commission Plan

Sales reps are incentivized based on the territory-wide performance, rather than that of individual sales. The commission plan promotes teamwork, where the commission amount is totalled and split equally among every rep.  It is widely used by companies with a retail sales model where multiple reps work towards making a sale.

When to Use It

If you can’t directly attribute new business closed to a single rep, this model is preferred. This commission plan ensures teamwork, where everyone comes together to achieve a territory target.

8. Revenue Commission Plan

As per this plan, the variable pay is a percentage of a single sale. Here, reps get to earn a flat percentage for every sale they make.

When to Use It

Revenue commission plans tend to work best if you’ve smaller sales teams and if your product/service isn't too complex. Also, these plans can be chosen if you’re looking to enter new territories or grow your market share.

9. Multiplier Commission Plan

A commission-based sales rep doesn’t have a base salary, and reps are paid only depending on the sales they make. The commission rates are higher than in other plans, and you save money on taxes, benefits, hiring, etc.

When to Use It

You can use this commission plan if you want to measure reps’ performance based on more than one factor like quotas, upsells, and add-ons. This also helps reps prioritize the deals that are of more significance, and drives particular sales behaviors accordingly.

Commission Structure Best Practices

Simplify Your Plan

Your commission plan should be as simple as possible, and shouldn’t be bombarded with lots of components. It must be easily understood by your reps to help them better structure their selling strategy.

Make it Realistic

When setting targets for your reps, make sure that it isn’t overly ambitious. If your reps feel that their target is out of their hands, demotivation will definitely creep in.

Ensure Flexibility

While you might forecast how the quarter will pan out, you cannot be entirely sure of the outcome. You might have to evaluate the way your reps are performing and go back to the drawing board to make modifications in the plan. To be able to do so, your initial plan should be flexible enough to be changed so that you’re on track with your revenue goals without causing too much confusion.

Know Industry Standards

The commission plans you create must be in sync with the industry you operate in. If the commission rate you pay your reps is higher than the industry standard, your profitability may take a hit. If it’s too low, finding the best salespeople can get difficult. And so, knowing the industry standards would help you create a competitive commission plan.

Winding Up

A thoughtful commission plan is non-negotiable if you want to onboard the right talent while also facilitating teams to reach your business goals. Considering this, it is important to create a fair and effective plan specifically tailored to each customer-facing role. Also, experiment with your plan so that you can figure out what the right one is for your business.

Managing commissions is going to be an uphill task irrespective of whether you’ve a simple or a complex plan. It can eat up a major chunk of your precious Operations time. Avoid the recurring busywork by automating your commission process. Also, to bring the best out of your reps, provide your reps transparency and real-time visibility of their commissions, and motivate them through gamifications. Everstage, the modern benchmark for commission management, helps you create a modern culture of trust, and keeps your sales teams driven. Book a demo now to take a closer look at our platform!

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