A Simple Guide to Sales Commission Structures
What is the best way to compensate your sales team?
This question has been hotly debated for years, as there are many sales commission structures at your disposal.
In this blog post, we will discuss some of the most common types of sales commission structures and how they work.
The Three Golden Rules of Commission Structures
Justin Lane, our resident sales compensation expert, shared three golden rules for designing an effective sales commission structure.
Don’t cap commissions
The best sales talent will not settle for a capped salary.
If you’re a founder or a manager, and you want the most motivating commission structure possible, check the ego at the door.
There’s a possibility your best rep will make more money than you, or show up with a nicer car, and that’s okay. That’s business.
Simplicity always wins
Generally, the simplest plans are the most effective at motivating reps.
The commission is your reps’ carrot. When you add multiple layers of complexity, your reps won’t know where to focus their energy. Or worse, they won’t understand how to get paid in the first place.If there's a possibility your best sales rep will make more money than you and show up in a nicer car, that's ok. That's business. #sales #leadership #spm Click To Tweet
Granted, the simplest plans aren’t always the best for business. The key is to strive for a plan that balances simplicity with your profitability objectives.
Make it make sense
Simplicity is one thing, but do your reps understand your structure?
Make it crystal clear to your reps how much commission they will earn on any given deal with performance dashboards or in a periodic commission report.
Once a manual task, you can now automate dashboards and custom reports using incentive compensation management software.
Sales Commission Structures
1. Base Salary plus Commission (Revenue Commission)
This is the basic commission structure that incorporates a fixed portion of pay (base salary) plus a variable portion of pay (commission). Variable pay is calculated using the value of a deal (revenue) multiplied by a commission rate.
Say your rep closes a $50,000 deal and has a 10% commission rate. In the next pay period, they will receive $5000 in commission, plus their base salary.
2. Gross Margin Commission
Similar to revenue commission in that sellers receive a base salary plus a portion of the sales, with the exception being that commission is calculated based on the gross margin, not revenue.
This structure is common in sales organizations with variable margins on the same product. Consider car dealerships, where this model is commonly used: the gross margin on a given model will vary based on negotiations.
Say a car salesperson closes two $50,000 sales for the same car, but one of the deals includes free servicing for the year worth $2000. The deal with free servicing will be less profitable for the dealership, leading to a lower commission payout to make up for the difference.
3. Variable Commission
When your sales team sells multiple products across multiple territories, a variable commission structure can help you motivate them to pursue deals that are desirable to your organization without detracting from their entire pipeline.
Variable commission structures assign varying commission rates to different deals. If a product is more profitable, or a market is more desirable, you may assign it a higher rate.When your team sells multiple products across different territories, a variable commission structure can help you motivate them to pursue more lucrative deals without detracting from the rest of the pipeline. #sales #salesmanagement #ICM Click To Tweet
The opposite is also true. For legacy products or verticals with high attrition, you can guide reps away from those deals with lower commission rates.
4. Tiered Commission
A tiered commission structure is the most common format for sales compensation plans at established sales organizations as it encourages reps to overperform without creating too much complexity.
These types of structures work by increasing (or decreasing) commission rates as reps attain milestones towards their quota.
At 0–50% of quota, a rep earns 3% commission.
At 50-75%, the rate increases to 4%.
At 75-100%, it increases again to 5%.
And finally, any deal over 100% quota earns them 7%.
5. Residual Commission
In a residual commission structure, employees continue to receive commissions on sales as long as they generate revenue.
Reps can benefit from the steady income that comes over time—but it also means one lost sale could significantly reduce earnings in an instant.
Residuals are common in sales organizations with no or low base pay, and where reps independently maintain a book of business.
6. Multiplier Commission
This style of commission structures allows organizations to motivate multiple sales activities at once. It’s most commonly used to encourage salespeople to upsell add-ons, more features, or complimentary products.
Here’s how it works:
Say a salesperson sells a base product for $100,000 and earns a 5% commission. If that same rep sells 5 units of insurance in the same sales period, their commission rate will multiply by 2x on all deals, leading to a 10% commission.
7. Straight Commission (Commission Only)
With this structure, there is no base pay, and reps are paid solely on commissions from sales. This is the most intense structure with the most upside—but also the most risk for reps.
This structure is generally discouraged unless:
- You have a large, low-skill salesforce with a large talent pool (i.e. telemarketing, door-to-door sales)
- Sales volume is high and cycles are fast
- A confident rep asks for it
Commission Structure Enhancements
You can transform a simple commission structure into a true motivator for your team members by introducing any one of the following elements.
Keep in mind that your plan should remain simple. If your sales team doesn’t understand the plan, it won’t motivate them to close.
This tactic uses positive reinforcement to motivate teams to reach quota. Sales accelerators are like power-ups to your commission structure.
In a tiered or multiplier commission structure, sales accelerators are the mechanism that increase commission rates as reps attain quota milestones, or hit certain upsell quotas.
On the other hand, you can use negative reinforcement to motivate reps to reach quota with sales decelerators.
In a tiered or multiplier commission structure, sales decelerators decrease commission rates on deals below quota.
Or on the off chance you don’t want reps to oversell, you can use decelerators to decrease commissions on deals over quota.
Draws on Commission
Think of draws on commission like pay advances on expected commissions.
Draws can help when onboarding new reps who are still getting a handle on the sales process. They are also employed in organizations with usage-based pricing where revenue isn’t realized until much later.
Draws on commission can also help smooth out pay variability if you have a seasonal business.
Whether a draw is paid back once commission is realized comes down to your policies. Maybe not for new reps, but certainly for revenue realized on usage.
Not quite an enhancement, but a policy that can encourage higher quality sales. Clawbacks are a commission mechanism that make reps pay back commissions on deals that churn early. For example, if a rep’s deal churns before four months, they have to give back the commission earned.
SPIFs, also known as Sales Performance Incentive Funds or spiffs, are short-term incentives outside of your main commission structure.
A strategically planned SPIF can give your team the boost it needs during a new product launch or slow quarter.
SPIFs are most commonly given as fixed bonuses or special perks.
What commission structure is right for you?
As with all things, the right commission structure depends on so many variables:
- Goals (profit or revenue?)
- Objectives (Product sales vs Up-selling)
- Talent pool (Skilled vs. Unskilled)
- Length of your sales cycle
- Sense of urgency
- And so much more
Distilling down the right answer for you simply isn’t possible without intimately knowing your sales process.
If you’re looking for some quick answers or guidance, let us know in the chatbox at the bottom right of your screen.