Sales commissions act as key motivators for sales representatives to close more deals. The happier your go-to-market teams are, the better your bottom lines. In this blog, you’ll see the different types of commission structures: fixed compensation, variable compensation, residual commission, split or team-based commission, and marginal or profit-sharing commission. Read on to find some kick-ass tips to create an effective commission structure.
According to this Gartner study, with every employee who leaves, organizations lose $19,000 + the cost of onboarding and attracting new talent. If you’re a sales-led organization - then the amount you’ll lose will multiply accordingly.
And with the current wave of great resignation and quiet quitting, the only way to retain such talent and avoid unnecessary losses is to provide competitive pay.
In this article, I’ll cover sales commission structures along with five proven tips to create an effective commission structure.
Top 5 Retail Sales Commission Structures
Before I jump to the different types of sales commission structures, let’s understand what it is.
Sales compensation structures are differentiated into two parts: fixed pay and variable pay.
The commission structures are a part of the variable pay. Commissions can be the percentage of the sales made that are given to the sales representatives.
They’re usually calculated on the following parameters:
- Gross profit.
- Revenue.
- Predefined quota.
- Nature of business.
- Level of skill needed to close the deal.
Now, let’s go into the different sales commission structures that are in practice.
Fixed commission
Fixed commissions are the most common and basic commission structures. They are also the easiest commission structure that can be calculated.
So who uses this model?
Businesses offering high-value or luxury goods usually adopt this type. Commissions are usually determined as a fixed percentage or as a lump sum model.
If a representative made 10 sales and they get 5% for each sale, then this means they’re 50% on top of their wages for that particular payout cycle.
However, if you’re giving a fixed commission as a lump sum, and if you don’t watch your bottom lines you can quickly run into a loss, especially with low-margin items that are sold.
Variable commission
A variable commission structure follows a tiered model and helps your representatives achieve higher targets. It is set in an incremental fashion for every new tier of sales unlocked.
In a variable commission structure, a representative can earn 5% as commission on top of every 10 units of LCD TVs sold, but if they sell 20 units they can start earning 10% on each sale.
This will motivate the rep to close more and reach the next tier of 10% from 5%, thereby increasing sales.
To utilize this commission structure, your deal values need to be clearly defined.
Moreover, if you have a high-performing representative in the team performing extremely well, you might have to give a bigger bulk payout. You also need to structure your commissions so that everyone has enough opportunities in their bucket.
Residual commission
Residual commission works as referral codes, payouts, or coupons. They’re usually a smaller percentage and offer your representatives a long-term passive income.
A number of luxury brands and car dealerships adopt this strategy to pay their representatives. This helps them build connections with people and also actively build a better brand for their product.
So, if you employ third-party sales teams or partners who advocate your product, you can pay them a certain sum every time they bring in a new client.
For every $500 purchase a rep can cash out 5% of the commission.
In addition, if the customer upgrades or buys add-ons they can cash out 2% for every sale made.
Split or team-based commission
A team-based commission structure is usually the key motivating factor that drives the entire team to perform. It also allows retailers to split commissions amongst the team members.
A team of 5 representatives will be paid 5% for every 10 units of sale they make.
Additionally, this commission structure also helps increase the brand’s profit margin and motivates employees.
Marginal or profit-sharing commission
Generally, profit-sharing commissions are used in car dealerships where the salespeople receive a set share of profits on a profit. The profit is split between the organization and the person at a particular percentage.
For every item sold the salesperson gets 20-50% of the profit and the company gets the rest.
5 Proven Tips for Creating an Effective Commission Structure
Here are a few tips to help you create a commission structure:
Choose the right commission structure
Every company is unique and the commission structures should be too. That’s why you need to narrow down on a structure that works for the products you sell and the one that is best for your bottom line.
For example, if you commission a variable pay structure for every 10 items sold, then you might run at a loss because those 10 items can be of lower value.
Additionally, set structures that drive revenue and also ensure that your employees are satisfied.
Set achievable targets
Commission structures alone don’t cut it, you need to set achievable targets for your people too. Realistic targets help your teams not burn out and churn.
In order to set the right target you need to study the current market trends and how sales will plummet or increase. For example, if you’re a fairy light manufacturer, you’ll be able to sell more during festive times like Christmas, Halloween, etc – allowing you to set higher targets.
Additionally, you should also try setting challenging targets. This will keep your team motivated to achieve more. If you want your people to be motivated, set targets that are achievable yet challenging which helps your team achieve.
Track employee performance
Commission structures help you plan better and improve your employee’s performance.
You also get an insight into who are your best performers. This helps you to give important deals to high-performing reps who have better chances to close the same.
Additionally, you can also figure out a commission structure that works best for your company to reach its goals.
Add sales caps
A sales cap is often used to control costs and ensures that your company does not overpay its sales force. It also helps encourage sales reps to focus on making high-quality sales, rather than just maximizing the amount of commission they receive.
The amount of the cap given to a representative can vary based on factors like:
- Salesperson's experience
- Type and cost of the product they’re selling
- Overall performance of the sales team
The cap is typically set at the start of the year and reviewed regularly to ensure that it remains appropriate and relevant.
Additionally, you should carefully consider the impact of sales caps on your team and regularly review and adjust the cap as needed.
Consider tax implications
Different states and countries have varied tax implications for the commissions paid. It also varies from industry and the amount paid in some cases.
In the US, retail sales commissions are considered taxable income and are subject to federal and state income taxes, as well as Social Security and Medicare taxes.
Here's a simple example of how the tax implications of retail sales commissions can affect a company:
The total annual payroll for the salespeople is $3 million ($50,000 x 100 + $20,000 x 100).
The company is responsible for withholding federal and state income taxes, as well as Social Security and Medicare taxes, from the employees' pay, including the sales commissions.
This results in an additional payroll tax expense of approximately $1 million ($3 million x 30% payroll tax rate).
In the above example, the tax implications result in increased payroll costs and additional responsibilities for the company. To avoid penalties, you need to consult with your legal teams before designing a commission structure.
Wrapping Up
A well-planned commission structure sets boundaries on what is achievable and expectations right away so that you don’t have to sort out confusion later.
Clearly defining commissions will improve business margins and make your salespeople happy. This helps your business achieve targets and ensures your reps keep closing happily.
Using the above methods you can start creating a commission structure that works best for your organization’s goals.
