Here at Sales Cookie, we help winning sales organizations automate their sales commission programs. One of the most important factor these organizations face is choosing the right sales commission structure. Which options are available? Which tradeoffs are involved? Which type of issues should you expect?
What Is A Sales Commission Structure?
A sales commission structure determines how you pay your employees, including:
- A set of incentive plans
- Ex: “Inside Sales Plan”, “Account Executive Plan”, “VP of Sales Plan”
- A list of eligible employees for each plan
- Ex: all US AEs excluding managers
- A definition of eligible deals
- Ex: only paid transactions whose account is marked as “strategic”
- A set of compensation goals (pay mix)
- Ex: the on-target compensation is $100K base plus $50K variable
- A corresponding payout structure
- Ex: three payment tiers, each paying a percentage of revenue
How To Assess Sales Commission Structures
To choose a commission structure, you must take into account various tradeoffs. Consider using a table such as the following to choose the option which makes the most sense to your business:
| Low | Medium | High | |
| Alignment | X | ||
| Fairness | X | ||
| Motivation | X | ||
| Simplicity | X | ||
| Predictability | X |
Here are some important metrics to consider:
- Alignment – how strongly commissions promote organizational sales goals
- Fairness – how fairly commissions reward true sales performance
- Motivation – how much commissions can motivate your team to deliver more
- Simplicity – how easy will it be to communicate your sales incentive program
- Predictability – how well can you forecast and control commission spend
Example #1 – Profit Based Commissions
This type of plan pays commissions which are not based on revenue, but based on profit (margin). Typically, they rely on a product catalog, which provides a base price for each product or service you offer. You can then pay commissions based on the difference between the price sold (total revenue) and the base price. For example, you could pay 6% of profit.
Some more sophisticated profit-based incentive plans use both a base AND a target price. The base price represents the product’s true cost. The target price represents the “expected sell price” for the product. You can then pay commissions using a combination – for example, 6% of the difference between the base price and cost, plus a more aggressive 12% of the difference between the target price and revenue. Learn more about profit based plans here.
Our scorecard:
- Alignment: High
- Fairness: Medium
- Motivation: Medium
- Simplicity: Low
- Predictability: High
Example #2 – Per-Deal Flat Commissions
This type of plan pays a flat commission per deal. For example, you could decide to pay $150 for each closed opportunity. You could also decide to multiply this flat commission amount by the order quantity. For example, an order for 3 units would results in a $450 commission (i.e. 3 times $150).
Some more sophisticated plans combine flat commissions with tiers. In this case, payouts increase with the number of units sold. For example, you could pay $200 per unit (instead of $150 per unit), but only if 100 units are sold during the same month. You could also choose to vary the flat amount based on the type of product sold (this of course requires catalog lookups). And you have to decide whether the higher rate applies to all sold units, or only units above a given threshold.
Our scorecard:
- Alignment: Medium
- Fairness: Low
- Motivation: High
- Simplicity: Medium
- Predictability: High
Example #3 – Bonus-Based Commissions
This type of plan pays cash bonuses for attaining certain performance tiers. Those performance tiers may be based on revenue, profit, or a score (ex: number of opportunities closed). For example, you could pay a $1000 commission for exceeding $10K in revenue, but $5000 for exceeding $15K in revenue.
Note that all bonuses don’t need to be flat amounts. They can also be calculated as a percentage of salary. For example, you could award a 10% salary bonus instead of a fixed cash amount. This can make it easier to automatically adjust bonuses based on seniority. Salary-based bonuses help you align commission spend with employee payroll, while encouraging employees to earn promotions.
Our scorecard:
- Alignment: Medium
- Fairness: Medium
- Motivation: High
- Simplicity: High
- Predictability: High
Example #4 – Revenue-Based Commissions
This type of plan pays a percentage of revenue, for example 8% of total revenue. In reality, most revenue-based plans have tiers (with accelerators), or even a minimum to attain (ex: a quota). Those tiers can be cumulative (ex: each tier pays a different rate for revenue within its band). Or they can be non-cumulative (ex: the highest attained tier determines the commission rate, which is then applied to all revenue).
If you’ve decided that a revenue-based approach is right for you, make sure you have a clear discounting policy in place. You definitely don’t want to end up in a situation where your reps sold large volumes with razor-thin margins (or even at a loss), while having to pay large commissions based on total revenue. While revenue-based plans are common, another issue is low predictability as revenue tends to fluctuate more than other metrics (ex: profit).
Our scorecard:
- Alignment: Medium
- Fairness: Medium
- Motivation: Medium
- Simplicity: High
- Predictability: Low
Non-cumulative tiered commissions
Example #5 – Team-Based (Or Split) Commissions
This type of plan pays commissions based on collective results. For example, your sales managers could be paid a commission based on their territory’s overall performance. Or you could pay commissions based on a shared metric (ex: a quarterly customer churn rate). Finally, you could decide to split commissions between individuals working together on deals (ex: an account manager and companion pre-sales engineer).
Now, each time you award a commission based on collective performance, you dilute its effect. Indeed, reps no longer have a 100% stake in “their” sales transaction. Some team members may choose to let others do the hard work. And you have higher potential for dissatisfaction if some individuals fail to contribute at the same level as others.
Our scorecard:
- Alignment: Medium
- Fairness: Low
- Motivation: Low
- Simplicity: Medium
- Predictability: Medium
Example #6 – New vs. Existing Commissions
This type of plan pays commissions differently for existing versus new business. You could introduce an additional bonus for bringing in new clients. Or the percentage of revenue paid may vary depending on the deal type (new vs. existing). Decreasing commissions for existing business helps ensure your reps don’t cruise or keep milking existing accounts.
At the same time, the lure of winning new accounts may force you to choose between spending your time servicing old clients and talking to new ones. Also, you need to decide what to do when a new account is transferred to a new rep (ex: because the previous rep left the company). Should it be treated as a new account?
Our scorecard:
- Alignment: High
- Fairness: High
- Motivation: Medium
- Simplicity: Medium
- Predictability: Medium
Example #7 – Recurring Commissions
This type of plan keeps paying commissions for deals which are recurring. For example, you could pay commissions in slices over a 12 month period because a year is the expected length of a subscription. However, if the customer cancels their subscription, the rep stops receiving commissions. This encourages reps to limit churn.
Note that you could also decide to pay a commission based on the contract’s value if the customer signs a multi-year contract. Finally, you could decide to include a bonus for renewals, or a penalty for cancellations. In all cases, we recommend representing each recurring transaction using a separate record in your CRM system in case amounts change (due to upgrades / downgrades / cancellations / tax changes).
Our scorecard:
- Alignment: High
- Fairness: Medium
- Motivation: Medium
- Simplicity: Low
- Predictability: High
Example #8 – Upfront Payment With Claw Backs
This type of plan assumes that “won” deals will in fact go through, that payment will be received from customers – and so allow upfront payment of commissions. Reps don’t need to wait for payment to be received from customers in order to receive their commissions. At the same time, those types of plans typically include a clause to recapture payment of commissions if money cannot be collected – i.e. a claw back or reversal clause.
Claw backs can be easy to manage – or they can be a real nightmare. The main deciding factor is whether you want to apply the cancellation to the original calculation period, or to the period during which you realized that payment would not come through. We strongly suggest using the second approach because the first comes with significant issues.
Our scorecard:
- Alignment: Medium
- Fairness: High
- Motivation: Medium
- Simplicity: Low
- Predictability: Medium
Example #9 – Plans With Draws
It takes time for any new rep to ramp up. New reps have the learn a new business, new products, new messaging, etc. They have to introduce themselves and form new relationships. For this reason, some commission plans include a guaranteed minimum payment. This type of minimum is called a draw. The draw’s amount could be fixed (ex: $5000 per month) or be based on salary (ex: 25% of monthly salary).
Draws can be non-recoverable, in which case the minimum payment does not need to be repaid. Draws can also be recoverable, in which case a balance is used to keep track of the amount of money owned by the rep to the organization. This balance is then repaid over time as reps receive larger commissions.
Our scorecard:
- Alignment: High
- Fairness: High
- Motivation: Low
- Simplicity: High (recoverable), Low (non-recoverable)
- Predictability: Low (recoverable), High (non-recoverable)
Example #10 – Plans With Both Earned Vs. Paid Commissions
Let’s end this post with one approach we would recommend avoiding at all costs! This type of plan declares commissions as earned, but only pays them over time as payment is received from customers. For example, a rep could have “earned” a $5000 January commission, but only be paid $3557 in January. Later, as payments are received from customers in February and March (for January deals), the rep receives incremental earned January commission payments.
This approach is problematic for several reasons. It results in fragmented commission statements. It is very difficult to calculate correctly. And it creates legal risks because some US states consider that any earned commission is owed and MUST be paid. There are better options available such as option #8 above, so there is little justification for this approach.
Our scorecard:
- Alignment: Medium
- Fairness: Low
- Motivation: Medium
- Simplicity: Low
- Predictability: Low
In Conclusion
In this article, we presented some winning sales commission structures, plus one you should avoid. We hope you’ll find one which matches your goals, and better understand tradeoffs associated with different approaches. Need more help? Reach out on our website. We’d love to help!
Sales Commissions Explained 