Commissions are a huge motivating factor in driving the performance of sales reps and ensuring steady revenue growth. Using commission caps in your compensation plans is unlikely to yield any positive results for a company. Instead, this strategy can backfire in a bad way wherein a company can not only lose out on potential revenue but also lose out on the best salespersons to competitors.
Sales commissions are standard in most sales roles and are used to motivate sales teams to deliver strong performances. As sales commissions (in most cases) are directly related to the number of sales made during a period, salespersons are driven to achieve their respective sales quotas.
You might be surprised to know this, but some companies can put a cap on sales commissions. In such situations, there is a strict limit on what your salespersons are allowed to earn during a period, irrespective of their true earning potential.
In this article, I’ll explain what commission caps are and why companies use them. I’ll also highlight 5 important reasons why you should avoid capping sales commissions.
What are Commission Caps?
Commission caps or capped commissions refer to a compensation structure with an upper limit on the commission a sales rep can earn.
In other words, capping sales commissions defines a ceiling beyond which a sales rep will not receive additional compensation, even if they generate more revenue for the company.
A company offers a 3% commission on sales of up to $500,000 in a quarter. However, they put a commission cap of $15,000 for each salesperson.
So, even if a sales rep clocks $30,000 in the period, the commission payment would still be $15,000.
Additionally, salespeople have made several arguments against capping commissions. The most prominent reason is that it restricts them from realizing their true potential.
However, some companies still pursue this strategy. Let's take a look at a few reasons why sales leaders of these organizations do so.
Why Organizations Cap Commission?
Here are three main reasons companies limit their commission payouts:
1. To avoid paying commissions on large deals
One of the biggest reasons given by companies for placing commission caps is the 'fear of overpayment'.
Let’s understand this with the below example.
A salesperson closes a deal worth $10 million. With a commission rate of 3%, the commission earned would be around $300,000. Due to the nature of the deal, a salesperson would go over and above to close it as soon as possible.
The company also stands to secure a revenue of $10 million – making it a win-win for all.
However, some companies might feel that paying such massive commissions is not ideal and put a cap in place. This can demotivate your salesforce, given that it could be one of the largest deals for the company.
2. To close deals at the right time
With commission caps, salespersons might try to distribute their deals over different periods instead of closing them in the same period. The rationale is that if they’re not going to earn more commission, then it’s better to close new deals later.
However, this approach can be risky.
How?
In competitive industries, other companies will also be vying for the same account. So, if you don’t act swiftly to close the deal, your competitor might beat you to it.
Moreover, delays could lead to numerous issues like the prospect changing their mind or the buyer quitting – resulting in the deal falling through.
3. To limit exposure to negative effects
Another possible reason could be that organizations cap commissions to deal with uncertainty.
Wondering what uncertainties?
It can be about things such as:
- Future.
- Efficacy of the compensation plan design.
- Balance of territory design.
- Accuracy of the sales quotas referenced throughout the plans.
So if these uncertainties don’t work out as planned, capping the commission could limit exposure to the negative effects.
4 Reasons You Shouldn't Cap Sales Commissions
Some of the most prominent reasons for the same are shared here:
1. Can impact employee drive to perform better
Commission caps limit the money salespersons can make and stop them from realizing their true earning potential.
This can cause a lack of motivation and effort from reps and lower their drive to exceed the specified number of sales. And demotivated sales teams are unlikely to go beyond the given sales quota, for they have nothing to gain out of that extra effort.
Moreover, when you define the limit of success for a sales professional, it acts like a brick wall on the path to the long-term success of your organization.
Additionally, most sales professionals hit their peak after spending 2-3 years in a role, and this peak starts to flatten out around the 5-year mark. By using commission caps, you risk losing out on the best salespersons even before they hit their peak.
As a result, other reps are also likely to feel demotivated and might not be able to deliver their best efforts to drive revenue growth for the company.
2. Can result in financial loss
You have to understand that capping commission also puts a limit on the performance of salespeople. While you might be able to limit the commission, your organization would also secure less revenue during that period.
As a result, your team will be caught in a vicious cycle of poor sales performance where lower commissions lead to lower revenues. This can further translate to financial problems – making it a losing proposition for everyone.
Moreover, there are chances that your competitors are likely to catch up to you sooner than you expected, as you have literally told your salespeople not to go beyond the specified sales quota.
3. Can deflect from the larger issue
No doubt commission caps are a strategy to reduce expenses as sales leaders fear spending more on compensation than they’ll make as revenue.
However, that might not be the case!
If your company is facing the issue of an imbalance between commission payments and revenue, then it’s likely a result of poor compensation planning. And capping commissions will not solve the root cause of the problem.
Instead, you need to build a robust compensation plan that addresses this issue. You should also ensure that the incentives offered are aligned with your company goals.
After all, you’re more likely to hit revenue growth targets by rewarding your sales reps.
And while you’re at it, here are some incentive compensation plans to consider.
4. Can allow competitors to poach your best talents
It goes without saying, better compensation packages are a big draw for leading salespersons as it maximizes their earning potential.
And to attract and retain the best sales talent, you need to offer just that!
One way of providing attractive compensation is by benchmarking your plan with industry standards.
Consequently, if you’re placing commission caps, you risk losing your best salespersons to competitors. And then you’ll have to spend considerable money and resources on replacing them with new professionals.
Summing Up
Capping commissions is a negative strategy that is unlikely to yield any benefits for your company. You might feel it to be a good option in the short term, but in the long run, this strategy can prove to be detrimental.
Instead, you need to ensure that your sales compensation plan is in sync with your overall business goals.
You also need to have strong incentive plans at the core of the sales plan for boosting revenue growth and sales performance!
