In the dynamic landscape of compensation methods for businesses and their employees, commission-based pay has established itself as a central and advantageous compensation strategy, especially in the sales industry.
Understanding the depth of what commission-based pay entails and how it can be effectively used is crucial for creating a balanced and motivation-driven work environment.
Commission-based pay is not only an economic benefit but also a powerful tool for shaping company culture and maximizing employee performance.
In this article, you will learn more about commission-based pay and whether it is the right compensation method for your business.
What is meant by commission-based pay?
Fundamentally, commission-based pay is compensation that the employee has the opportunity to influence. Often, it involves meeting specific goals, but it can also be tied to pure sales. Commission-based pay is usually just one part of the employee’s total compensation.
What does commission-based pay involve?
What does commission-based pay involve? Commission-based pay is the part of the employee’s salary directly linked to their performance. It’s most common in commercial roles such as sales, marketing, and customer service professions. However, it can also occur among project managers and product owners. In the case of a salesperson, sales results are the performance they are measured on. An employee who sells more will earn more money—it’s as simple as that.
Especially among salespeople and marketers, commission-based pay is often based on a sales target. This could mean a salesperson receives 5% of the sales value in commission. Additionally, it is common for the commission to vary depending on the product, the discounts offered by the salesperson, and how the salesperson is performing against their budget.
Should you use commission-based pay in your business?
It’s not entirely easy to give a direct answer to whether commission-based pay is something your business should use. However, we can provide three important perspectives to consider before making a decision.
1. What culture do you want to build?
How your commission-based pay looks will directly influence the culture that is formed. By offering low base salaries and high individual commissions, you are likely to build a more individualistic culture. People with high drive and a desire to influence their income will likely thrive. Consider the type of employees you want to attract and, the culture you want to build, and make your decision accordingly.
2. Which sales aspects are most important to you?
Since your commission-based pay is an incentive for your employees, it will also influence their behavior. Therefore, it is important to think about what kind of behavior you would like to see from your employees. Is it most important for you to acquire new customers, or is it to sell more to your existing ones? Perhaps there are specific products or services you want to grow—ensure that these are more valuable to your employees. Consider the various sales aspects, prioritize them, and use this information when making your decision.
3. How does commission-based pay affect your customers?
It is easy to get stuck in the internal perspective and forget how commission-based pay actually affects your customers. When your employees earn more in their paychecks by selling more, it will also influence their behavior toward your customers. Perhaps they recommend a product that doesn’t fit the customer’s needs because it offers a higher commission. Therefore, make sure to thoroughly consider how potential commissions will affect your employees’ interactions and, ultimately, your customers.
That being said, commission-based pay is common in commercial roles, and our candidate survey “The Sales Landscape 2023” shows that 88% of participants appreciate a salary with variable components. Our survey also revealed that the pension plan was important to the participants.
Pros and cons of commission-based pay in the company
There are many pros and cons to introducing commission-based pay in your business. We will now cover some of the most important aspects you need to know when designing your commission model.
- Motivation: It can increase employee performance and sales because they have strong incentives, especially when they exceed their goals.
- Cost efficiency: Salary costs move in proportion to sales, providing natural scalability.
- Reduced risk: Since salaries are commission-based, costs also decrease if sales do not go as planned. Often, base salaries are also lower than target salaries, reducing overhead costs.
- Focus: Allows you to direct employee focus on different parts of the business with the right commission model.
- Attract and retain talent: For driven and motivated salespeople, substantial commission-based pay can be a reason to work for your company. Those accustomed to a high monthly salary are also easier to retain.
- High risk: A significant risk is what Megadeals calls rainmaker dependency, meaning the company relies on a few individuals for most sales. If the person is motivated by money and sells a lot, there is always a risk they will take the customers to another company.
- Short-term focus: There is a risk that your employees make short-term decisions and deals they shouldn’t, solely to get the commission.
- Internal competition: If you have individual commission-based pay, there is a risk of unhealthy internal competition. This can lead to lost business and, in the worst case, even employees.
- Loss of talent: If your employees’ main motivation is money and high commissions, there is a risk they will leave your company as soon as someone else can offer more money.
- Internal inequalities: It is challenging to create a fair commission model because there will always be many different types of customers. For example, how do you differentiate between new customer sales and upselling?
Tips for managing and optimizing a commission-based pay system:
First and foremost, all employees must understand commission-based pay and how they can influence their income. Secondly, it is a good idea to have regular follow-ups with employees to ensure that everything is working as intended. The third and final tip is to constantly review the balance to ensure it is a profitable deal for the company and that employees feel valued.
How commission-based pay works in practice:
In practice, an employee’s salary consists of a fixed base salary. The exact proportion of the base salary varies from company to company, often ranging from 50% to 80% of the total salary. The rest is the commission-based pay, and as mentioned earlier, it is variable and based on the employee’s performance.
Some companies also have some form of bonus that is distributed semi-annually or once a year. It often depends on the entire company’s performance or achieved goals.
What advantages and disadvantages does commission-based pay offer employees?
As commission-based pay affects your company, there are also pros and cons for your employees. Therefore, you will learn about some important aspects related to how it affects your employees.
Pros for employees:
- Higher income: Commission-based pay allows employees to earn more than if they had a fixed salary.
- Influence: There is an opportunity to increase income each month with increased performance.
- Flexibility: Many companies offer a high degree of freedom with responsibility. This means you can work wherever you want and as much as you want. If you want to work more than 40 hours and exceed your goals, there is often a reward for the hard work.
- Personal development: Since work is extremely measurable, there is an opportunity to develop your skills and see results directly in both work and income.
- Motivation: For those driven by money, it can be the motivation needed to work hard, even on difficult days.
Cons for employees:
- Uneven income: Commission-based pay makes the employee’s income vary significantly from month to month, making it difficult to plan personal finances.
- Perceived injustice: Sales can fluctuate depending on what happens in the world, making it feel unfair to get paid less when you are doing the same work.
- Stress and pressure: Constantly chasing new goals and achievements can create stress and pressure on the employee.
- High competition: Internal competition can be very tough, leading to conflicts about who owns which customer.
- Ethical risks: Employees may be tempted to sell things the customer does not need or price solutions incorrectly to increase their commission.
Commission-based pay for Salespeople: An incentive to perform
Why is commission-based pay common in the sales industry?
Commission-based pay is a common compensation method in the sales industry for several good reasons. Firstly, it provides salespeople with a direct financial incentive to increase their performance. When their compensation is directly tied to the sales results they achieve, they are more likely to strive to reach and exceed their goals. It creates a natural drive for increased sales and better results.
It also allows companies to minimize their fixed costs. Instead of paying high base salaries to salespeople, companies can use commission-based pay to link salary costs directly to sales results. This means that companies can adjust their expenses according to their income.
How can salespeople benefit from commission-based pay?
For salespeople, commission-based pay can be highly advantageous. Firstly, it allows them to earn more money by increasing their performance. When they exceed their sales goals, they are rewarded with higher compensation. This can be particularly advantageous if they are skilled at selling and have a strong customer base.
Additionally, commission-based pay gives salespeople control over their income. They can influence their salaries through their effort and ability to sell. This can be particularly motivating for those who are self-driven and want to increase their incomes.
Salespeople’s responsibility in a commission-based pay system:
In a commission-based pay system, salespeople have a significant responsibility to perform and achieve their sales goals. They must be self-directed and can build and maintain customer relationships, identify sales opportunities, and close deals. Salespeople must be diligent in following the company’s guidelines and processes to ensure that sales are recorded correctly and that they receive the right compensation. In a commission-based pay system, their ability to sell and deliver results directly impacts their income, making it their responsibility to perform at the highest level.
What is a commission-based pay template?
A commission-based pay template is a valuable tool used by many companies to create structure and clarity around how the commission-based pay system works. It is essentially a predefined template or table that outlines the various parts of commission-based pay, including sales goals, commission levels, and how sales revenue is converted into compensation for employees. The template is customized based on the company’s specific needs and objectives.
How can a template be beneficial for companies and employees?
For companies, a commission-based pay template offers several advantages. It creates clarity and transparency in sales and performance goals and helps reduce potential conflicts or misunderstandings. Additionally, it can serve as a strong incentive for employees to achieve their goals and maximize their compensation. Companies can customize the template to strike a balance between rewarding performance and maintaining salary costs within reasonable limits.
For employees, a commission-based pay template provides clarity and predictability. They know exactly how their performance is rewarded and can see what goals they need to achieve to increase their earnings. This can enhance motivation and engagement among employees, encouraging them to strive for better results.
Example of a commission-based pay template:
Here is a very simple example of a commission-based pay template:
|Up to 100,000 SEK
|5% of sales
|100,001 – 200,000 SEK
|7% of sales
|Above 200,000 SEK
|10% of sales
In this example, the sales goals that employees must achieve are clearly defined, and the commission levels are established based on the size of the sales revenue. This template can be customized, and complexity can be increased depending on the company’s needs. However, it provides an overview of how such a template can look and be used to reward performance.
Variable Piece Rate or Commission-Based Pay: Differences and Similarities
What is the difference between variable piece rate and commission-based pay?
Variable piece rate and commission-based pay are two different methods of linking compensation to performance, but they have their unique characteristics. While both systems aim to motivate employees to perform better, they differ in how they achieve that goal.
Variable piece rate is common in production and manufacturing. Piece-rate pay rewards employees based on their production and work effort. In this system, they earn more when they produce more, and the pay is often directly linked to the quantity they produce.
Commission-based pay, on the other hand, is more common in sales and rewards employees in the form of a percentage of the sales revenue they generate. In this case, compensation is tied to sales results and not to production or work effort.
When is it appropriate to use variable piece rate or commission-based pay?
The choice between a variable piece rate and commission-based pay depends on the company’s industry, goals, and structure. Variable piece rate is best suited for production and manufacturing, where performance can be measured in terms of the number of units produced or work effort. Commission-based pay, on the other hand, is more suitable for sales and service industries, where performance is linked to sales results and revenue generation.
It is important to consider the specific goals of the company and the type of performance that needs to be encouraged. Regardless of the method used, it must be fair and motivating for employees.
Examples of companies using variable piece rates or commission-based pay:
Many companies use variable piece rates or commission-based pay as part of their compensation structure. In the manufacturing industry, companies like car manufacturers and furniture producers may use variable piece rate pay to reward their production staff.
In sales, companies such as Apple, Google, and Amazon may use commission-based pay systems for their sales and marketing staff. These systems can vary in complexity and details depending on the company’s needs and goals, but they always aim to create incentives for better performance and results.
Summary of Commission-Based Pay
In summary, commission-based pay is a form of compensation where the employee’s income is directly related to their performance and sales results. The benefits range from reduced fixed costs for companies to increased motivation for employees.
To use commission-based pay effectively, a careful balance between rewarding performance and managing potential risks is required. Clarity, communication, and regular follow-ups are key to creating a sustainable and fair commission model.
How Salesonomics Can Help You Set the Right Commission-Based Pay
At Salesonomics, we have extensive experience in developing the right strategy for your commission-based pay and fixed salaries in business-critical roles. We are happy to act as a sounding board in designing both salary models and organizing the sales force. You can be confident that with our help, you will establish the right structure for your new and existing salespeople to succeed. Feel free to contact us to learn more about how we can assist you.