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Sales commissions

The Pros and Cons of Sales Commissions

Jason Kruger

Chief Financial Officer at Signature Analytics
Jason has more than 16 years of accounting and finance experience in both public and private industry accounting. Since 2008, Jason has acted as the CFO for many of Signature Analytics’ clients, providing them with the financial analysis they need to grow their business and make more data driven decisions. He has direct experience with many complex accounting and financial issues within a variety of companies and industries, including software, technology, biotech, manufacturing, food/beverage, apparel, construction and advertising.

Compensation for most employees is a fairly straightforward process. Finding the best compensation plan for sales employees is a bit trickier. Your company’s sales department is one of the most important parts of the organization. After all, sales representatives are the ones bringing in the money and new customers.

Finding the right sales compensation plan can be difficult. On one hand, you want to find a way to pay sales employees that rewards them for their performance. On the other, you don’t want to set the goals so high as to be unattainable.


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Types of compensation

Before we get into the details of the best way to compensate salespeople, let’s run down the basic compensation structures for sales employees.

  • Straight Salary: This plan offers no commission. Employees get a regular salary every paycheck.
  • Salary Plus Bonus: This plan provides a straight salary plus bonuses when company-defined targets are met.
  • Base Salary Plus Commission: In this plan, employees receive a salary as well as a small commission.
  • Straight Commission: This plan compensates employees strictly on a percentage of sales. There is no salary and employees don’t receive income based on hours worked.
  • Variable Commission: This plan is similar to a straight commission, but the rate changes based on whether the salesperson meets or exceeds sales goals.
  • Draw Against Commission: This plan ensures the employee has some cash coming in every pay period by paying a specified amount, which is deducted from earned commissions in future pay periods.
  • Residual Commission: Companies with steady clients may choose to pay under this plan. Salespeople receive a commission on a client’s first sale and may typically receive a smaller commission for future orders.


Choosing the best plan

In order to choose the best way to compensate a company’s sales staff, you need to look at two areas. First, you must take the type of startup into consideration. A retail store relies heavily on its sales staff, while a business such as a research lab may be more driven by scientists and medical researchers. Second, you need to decide what your sales objective is.

Defining your sales objectives

Sometimes, setting compensation incentives strictly on sales isn’t in line with the company’s sales objectives. Here are some examples of sales goals your organization may want to focus on:

  • Adding new customers
  • Increasing the size of the average order
  • Improving customer retention
  • Selling products with a higher profit margin

The pros and cons of commission

Commission plans have advantages for employers and employees, but they have drawbacks as well. When deciding if a commission plan is right for your sales staff, keep in mind the sales targets must be attainable.

Pros

Here are some of the positive aspects of commission plans:

  • You Pay for Performance: Commission plans reward performance. Paying when your sales team reaches its financial objectives makes it easier to maintain a sales budget.
  • Attracts Best Salespeople: Since commission selling provides higher earning potential than a straight salary plan, it tends to attract top-performing salespeople who know they have the skills to produce a good income.
  • High Motivator: Commission selling typically motivates sales staff to push themselves harder in order to make the most income. It encourages friendly competition among employees.
  • Flexible Schedules: Commission salespeople tend to create their own schedules, which promotes morale and employee satisfaction.
  • Easy to Understand: The system is easy to understand and calculate.
  • Better Value: Under commission-only plans, you’re paying employees based solely on their sales, which is ultimately more economical for the company. This makes it a good plan for startups without a steady cash flow.

Cons

Here are some of the drawbacks of commission plans, particularly commission-only plans:

  • Aggressive Sales: Commission selling can lead to aggressive behavior from sales employees, causing them to use high-pressure sales techniques. This can scare off customers and your company’s reputation could suffer.
  • Aggressive Environment: While commission selling can create friendly competition, it can also create aggressive competition, which can lead to an uncomfortable work environment.
  • Extreme Differences in Pay: Commission sales can create wide variations in sales employees’ income.
  • Refusal of Career Advancement: Salespeople who are highly compensated might not want to move into available managerial positions because it could represent a pay cut.
  • Neglected Duties: Salespeople may neglect any non-sales related aspect of their job, including service duties.
  • Low Job Security: There’s no guaranteed income for employees. An economic downturn can mean loss of income for salespeople, causing high turnover.
  • Stress: The stress resulting from the uncertainty of commission selling could lead to employees burning out.
  • Scare off Employees or Potential Employees: We mentioned earlier that commission selling attracts the best salespeople, but the other side of the coin is it may scare off talented salespeople who don’t like working under pressure or who can’t afford to start a job with no guarantee of income.
  • Profitability: Paying salespeople a fixed commission on revenue means higher sales volumes are equally as profitable as lower sales volumes, which is bad for the company’s bottom line.
  • Difficult to Administer: Should you pay on billings or receipts? Payment on billings means the salesperson may make sales without considering the customer’s ability to pay. On the other hand, paying on receipts is more difficult to administer and may lead to the employee trying to collect from the customer forcefully.


How much to pay

If you’ve decided to go with a salary plus commission plan or already have one in place, you may be wondering what level of compensation is adequate and how much is too much. Unfortunately, there’s not one good answer for all situations.

A common mistake business owners make is to copy a competitor’s plan and fine-tune it to fit their budget. Your company’s compensation plan should be unique to your business’ products and services, as well as your budget.

Let’s look at some examples to give you a starting point. If you’re paying salary plus commission, start with the total remuneration you believe is appropriate for a sales rep. Keep in mind that seasoned salespeople may demand more compensation, while a representative just starting out may be satisfied with working on commission only.

If a company has few competitors and is well-known, it may decide on a 50/50 split of base salary to commissions. A company in a highly competitive field may offer a mix of 20/80, or perhaps go to a commission-only plan.

Many organizations add bonuses into the mix to further incentivize sales staff who hit target profits. The bonus can come in the form of cash, trips, gift cards or other high-ticket items. The nice part of these types of bonuses is the earnings brought in by the employees that fund them.

Finally, determine if you’d like to offer a flat or variable commission structure. A flat rate is usually reserved for less-profitable products, while a variable commission is used to incentivize sales staff to sell a company’s best-selling or principal products.

The best plan

Ultimately, the best commission plan is the one that works well for your startup specifically. Make sure the commission plan is consistent and easy for employees to understand. Keep the lines of communication open with your sales team and explain their earnings to them each month and each quarter. Finally, it’s a good idea to run your commission plan by an attorney or other professional to iron out small details.

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