How to Set the Commission Structure for your Sales Team?
How you pay your sales reps can have a significant impact on your organization’s profitability and sales turnover rates. In addition, it can help determine whether top sales talents will be willing to work for your organization and how long you will be able to retain your current top performers.
As a sales leader, you have to understand how the commission structure works and how to set a commission plan that will benefit everyone. Choosing the right commission structure can motivate your sales reps to close more deals which generally improve your sales funnel bottom line.
In light of this, we will highlight the most common commission structures that sales organizations use to pay their salespeople. Moreover, we will provide practical examples of how to calculate your sales team’s total commission (where needed), so you can make the right calculations.
What is a sales commission structure?
For every new sale a salesperson makes, the sales commission is the amount they receive from their sales organization. A sales commission structure explains how sales reps are compensated or rewarded for their sales performance (selling products or services to clients).
In the sales industry, commissions are typically based on a percentage of sales or the final cost of sales. Sales agents often receive commissions as a supplement to their standard salary. They may receive it weekly, biweekly, monthly, or quarterly.
Types of sales commission structures
Not all sales commissions are structured or planned the same way. This is because businesses that deal with selling products or services base their compensation plans on a few commission structures. Understanding some of these structures is crucial to know which is best for your business.
The following are the most common commission plans or structures in the sales industry:
Base Rate Only Commission
This sales commission structure involves paying sales reps only a standard salary or flat hourly rate. In this commission plan, sales reps receive no reward or compensation for selling more products or services. This model is uncommon in the sales industry and does not include commission rates, bonuses, or other incentives.
For example, let’s say your salesperson is paid $5,000 per month; this amount is fixed no matter how many sales he makes within this time period.
You don’t need any calculation for base rate only commission (or base pay-only model) since there’s zero commission involved.
Base Salary plus Commission
In this sales commission structure, sales reps are paid a commission with a fixed salary. The standard ratio of base salary to the commission paid to them is 60:40. That is, 60% is the base salary rate (which is fixed), while the 40% is the commission rate and could even vary.
Let’s say your salespeople earn $5,000 individually per month in salary with a 20% commission rate. That is $1,000 for $5,000 worth in sales. If each brings in $50,000 of sales in one month, each salesperson will earn $15,000 (that is, $10,000 in commission and $5,000 in salary) for that particular month.
The formula for base salary plus commission is given below.
Total commission = (Commission Percentage x Amount Sold) + Straight Base Salary.
This commission structure is ideal for sales organizations looking to retain their top performers. It’s a plan to motivate top-performing sales reps to fully invest their skills and time to sell more for the company they represent.
Draw against a Commission
This is a commission model that incorporates elements of the commission-only and base salary plus commission structures. Here, sales reps are eligible to draw or receive a certain amount of guaranteed pay each month at the beginning of the sales period. It allows sales reps to receive payment in advance to motivate them to exceed their sales performance.
For instance, a sales rep is expected to earn $5,000 a month in commission and receive $2,500 monthly in a draw. If the $5,000 goal is met, that sales rep will receive $2,500 more, the amount over the draw to complete the monthly payment in commission. However, if only $2,000 was earned, such a sales rep will owe the organization $500, which is the amount under the draw.
The calculation in our example is done using the formula below.
Commission owed = Commission Total – Amount Draw or received in advance.
The commission draw structure is ideal for companies that want to support new hires who may need time to ramp up production. It’s also ideal for companies undergoing growth uncertainty.
Gross Margin Commission
This is a commission structure where sales reps are paid a certain percentage after considering the expenses or final cost associated with the sales they make. Here, sales agents earn only a percentage of the sales profit in commission.
For example, a salesperson could sell a $50,000 product that costs $20,000 to produce. The gross margin is calculated to be $30,000. The salesperson may earn 5% on the margin, which is $1,500 in compensation.
Note: in the above calculation, we use the formula below to get the total commission.
Total commission = Gross Margin x Commission Percentage
Gross Margin = Total Sales Price – Cost
This structure is ideal for sales organizations that want to ensure every sales transaction supports the bottom of the sales funnel. This structure gives chances to top performers to earn more in commission.
In this commission structure, sales reps earn a certain percentage in commission for the total amount of sales deals they close. This model is more about achieving larger business goals than focusing on profit only.
For example, let’s say you set your commission percentage at 5%, and your salesperson sells a $5,000 worth of product. Such a salesperson will earn $250 in revenue commission for that sales deal.
The formula for calculating your revenue commission is given as follows;
Total Commission = Sales Price x Commission Percentage
The revenue commission structure is ideal for sales organizations that offer products or services with set price points.
Straight Commission Plan or Structure
This commission structure bases compensation on the number of sales a sales agent completes. Here, sales reps receive no base salary but earn money in commission only when they make sales. As salespeople earn no income for no sale, there’s also a greater chance to earn big in commission from this structure.
For example, a sales rep that sells a particular product earns 7 percent for every sale made. If that rep sells a total of $5,000 worth of product, he gets $350 in commission. However, if no sale is generated, he gets no income.
You can calculate your straight commission using the formula below;
Income = Sales x Commission Rate
This commission structure is ideal for companies that want to save money on taxes, benefits, and other expenses since no salary is paid. However, a high commission rate usually accompanies this model to attract top salespeople who can bring in more revenue.
This commission structure involves paying sales agents a certain percentage of commission on all sales they close up to a designated amount in revenue. In this commission structure, the sales rep’s commission rate increases after making a certain amount of sales or exceeding a certain revenue benchmark.
For example, a salesperson earns 5% of commission or $2,500 on all sales up to $50,000 in revenue. That commission increases to 8% or $8,000 for all sales up to $100,000 in revenue. For closing a deal worth $200,000 in revenue, he earns 12% commission by tier or $24,000 in commission.
The formula used for our calculation is given below:
Commission by tier = Commission Percentage x Designated Amount in Revenue
This commission structure is great for sales organizations who want to motivate top-performing sales reps to keep hitting their quota.
Your sales team should be compensated based on the right commission structure. It is necessary to create a commission plan that motivates your sales representatives to continue to close more sales. You can rely on the information in this article to determine the type of commission structure that would work best for your sales team.
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